Most business owners think that they simply will sell their business to a third party when they are ready to retire. But consider this: less than one in four of the businesses that go on the market for sale actually sell. And while it is true that a third-party sale of a business typically results in a higher gross sale price for a business than an internal transfer, an external sale may not always be the best option. It seems to reason that you should seek the highest sale price, but there are a number of other things that you need to consider.
First, you need to understand what you likely will net from the transaction after taxes and fees, which can be significant -- frequently at least 30% and can be as high as 50% or 60% of the sale proceeds. Additionally, you need to carefully and equally assess the non-financial characteristics of a transfer. The decisions you make will affect your employees, your legacy, your family, and ultimately, your future. So, how do you figure out what kind of transition is right for your business and situation? Here are a few financial and the non-financial questions to ask yourself:
- How much do I need to net from my transition?
- How much will I net from the option I choose?
- Will my transfer option provide enough to support my desired lifestyle?
- What will happen to my employees?
- Will my business remain in my community?
- Do I want to remain involved with my business after the transition? If yes, for how long?
- Could I work for a new owner?
An internal transfer or sale may provide a better option for owners to achieve their financial and non-financial long-term goals. There are many benefits of selling your business internally that should be considered, such as:
- Insiders already know the business, which means less disruption and a smoother transition.
- Owners can negotiate a level of involvement that fits with their own personal goals.
- Internal sales may be structured in a more tax-efficient manner that minimizes owner risk and keeps more of the proceeds in the seller’s pocket.
- Loyal partners, employees, or family members are more likely to carry on the seller’s legacy than outside buyers would.
- Internal options enable owners to reward key managers, employees, or family members who are involved in the business.
The internal sale can provide some great advantages over the external sale but still requires advance planning and preparation such as identifying and preparing a successor and being sure the business and owner are ready for the pending transition. Since there are several types of internal sale methods, the best structure needs to be identified in order to achieve the owner’s financial and non-financial goals and objectives. Let’s look at some of the most common internal transfer options:
An ESOP is created when a sole owner, or family of owners, wants to sell all or a portion of their company’s shares to ALL of their employees. The major benefits of an ESOP include preferential tax treatment and all of the people who helped build the company are included. The owner also gets to transition out gradually while leaving in place the people that know and care the most about the future of the business.
Many owners think that the transition out of their businesses may best be handled internally and privately by selling to managers. Because they are already part of the company, many owners are willing to give the managers this option on the condition that they can learn to effectively run the company so there are profits to facilitate the transaction.
Gift or Sell to Family Members
Owners can transfer the ownership of their businesses to their children or other family members by either selling or gifting shares. There are several things for owners to consider here in order to avoid issues including whether to include only those who are involved in the business or others as well.
True business succession requires a whole lot more than a piece of paper transferring title -- it requires careful planning, time, communication, training, mentoring, and most of all, the selection of the correct successor.
We recommend that owners begin this process 3 to 5 years in advance of a desired transition date. Developing a Business Ownership Transition Plan not only provides owners with the blueprint they need to achieve their own goals, but it also can provide incentives and a foundation for the next generation of company leaders.