Selling or transferring your business internally rather than externally generally offers a distinct advantage: you already have an identified buyer or successor with a working knowledge of the business and an interest in acquiring it.
Since an internal buyer has probably been involved with the business for a substantial period of time and is most often a key manager, family member, or co-owner, he or she has helped shape its culture and position within the community.
In an internal sale, the owner often has the flexibility to remain as involved as he or she desires, which provides time for the new owner to adjust to a new role and receive mentoring and support from the former owner. This can provide the business with a greater chance of continuity and success beyond the transition.
This option provides some great advantages over an 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. There are many decisions to be made.
14 Key Elements to Consider When Planning For a Successful Internal Business Transfer:
- Financial Structure – The internal sale of a business is usually funded via seller financing, the profits of the business, or in the case of a leveraged buy-out, third-party financing. Generally, in an internal sale, the seller does not receive a large amount of cash up front, but down payments can be required.
- Value Used for Transfer – Owners may sell their shares internally at market value if the financing and business cash flow are sufficient. However, some internal transfers are governed by strict IRS guidelines, such as Employee Stock Ownership Plans and gifting, so fair market value (FMV) must be used. FMV is usually less than market value.
- Percentage of Business Typically Sold – Internal transfer options generally allow for a more flexible transfer structure than their external counterparts, offering sellers the ability to sell a small percentage of their ownership up to and including 100% all at once or over time.
- Owner Perks – Depending on the time and percentage of ownership sold or transferred, the perks to an owner can continue during a sale period and be phased out over time. This provides great flexibility to an owner for the continuation of his or her existing benefits.
- Owner Income Stream – The internal sale option provides the most flexibility and possible continuity for income to the owner. An owner can choose to remain involved on a part or full-time basis during the transition and may be able to share in the increase in business value as well.
- Typical Tax Treatment – Some internal transfer options, such as the Employee Stock Ownership Plan, can provide dramatic tax savings. Through proper planning, other forms of internal transfers can be optimized to limit the ordinary income tax and receive the more favorable capital gains tax treatment.
- Fees – With the exception of the ESOP, which can have substantial fees due to its complex nature and IRS requirements, most internal transfer options do not have substantial fees associated with them. The majority of the fees incurred will be legal, accounting, and consulting in nature. Rarely will brokerage or sell side fees be incurred in these types of transfers since the buyer is already identified.
- Preservation of Legacy – The preservation of legacy and the continued employment of current employees and management is generally under the seller’s control in an internal sale.
- Operational Control – Operational control of the business will normally continue until the exiting owner is ready to hand over the reins and the successor is ready to take charge. In the case of an Employee Stock Ownership Plan or a stock redemption plan, the owner can maintain complete legal control over the business for many years, if structured correctly.
- Level of Seller Involvement – Seller involvement can vary and is at the discretion of the owner. Most sellers taper down their involvement over time so it does not negatively impact the business.
- Due Diligence – Due diligence is usually limited since the incoming buyer is very familiar with the business and most likely has been involved with the company in a senior position for quite some time.
- Degree of Difficulty of Transition – The internal sale can be a bit easier to accomplish than an external sale but a strong management team must be in place. Planning for the training, education, and development of new leaders takes time and effort. Adequately assessing the skills, abilities, talents, and desires of the incoming team, are critical to the continued success of the company.
- Disruption to the Company – The internal sale generally creates the least disruption to the company, typically appearing as a rather seamless occurrence to employees. The culture of the company is generally maintained.
- Impact on Employee Morale –The internal sale can produce a positive impact on employee morale. Employees who might have been fearful for their future when employed by a company owned by an aging owner can now be reassured of business continuity. Top-level management is generally involved in an internal sale, and their new leadership role can re-energize a company.
As you can see, there are lots of considerations with an internal transfer and the best strategy needs to be identified in order to achieve the owner’s goals and objectives. Therefore, we recommend you begin this process 3 to 5 years in advance of your desired transition date.