When it comes time to sell or transfer your business, what is the best way for you to do it? You have several options at your disposal, from giving it away, to going public, to doing nothing. Each comes with its own rewards, and pitfalls, that you should take into account as you develop your business succession and estate plans.
Private Equity Recapitalization:
Selling a majority stake to a venture capital firm often brings dreams of immediate wealth to business owners. But the influx of cash often has trade-offs. The founder is no longer the boss but instead an employee minority shareholder. Many of the perks of business ownership can disappear in the new ownership’s quest to grow profits quickly. In some cases the founding owner(s) may disapprove of the new direction of the company. They may decide to either leave the company altogether, or try to buy back majority ownership of the company, often at a higher price than what they sold for.
Employee Stock Ownership Plan:
Employee Stock Ownership Plans (ESOPs) can create a market for company stock of departing shareholders. As the seller, you can stay with the business and even retain operating control. It is both a great way to motivate and reward employees, and take advantage of tax incentives.
But very few businesses fit the ESOP profile (requires $2 to $3 million in revenue and 20+ employees). In addition, you probably won’t get all the money up front. Most of the money will come over time, financed by the company’s cash flow.
Transfer the Business as a Gift:
Gifting shares in a business to family members can reduce an owner’s stake in the business over time. This may be a great way for owners to pass their businesses down to the next generation to create a family legacy. It can be, however, very complicated and with changing tax laws, the advantages you originally sought may not be realized. Another downside: There is no cash from the transaction. This means the owner will still be reliant on the business for income, and thus may never truly exit the business. Therefore, your retirement plan should be able to support you throughout retirement without any proceeds from the sale of the business.
Sale to an Outside Buyer:
Selling a business may get the owner the most dollars — but there could be negatives: Taxes are one. In an asset sale, capital gains taxes can wipe out 50 percent of the sale proceeds. Another negative is that confidential company information (such as clients, employee salaries and gross margins) need to be revealed to prospective buyers. Owners have to share this information with no guarantee that the buyer will make an offer, let alone an acceptable one. The reality is that a successful sale to an outsider happens less than a quarter of the time.
In addition, the owner will need to focus more of their energies on the drivers of value in preparation for selling the business, such as keeping employees loyal, managing expenses or creating production efficiencies that will make the company more appealing to potential buyers.
In a management buy-out, the buyer, which could include a family member, key lieutenant or group of managers, knows the business and are passionate about its continued growth and success. That is a key benefit. On the other hand, the buyer often has limited funds available, so the business owner may have to take the sale price in installments. This can become problematic when a great employee proves to be a bad entrepreneur and owners need to take back the business in a couple of years — having been paid only a portion of the sales price — with the continuation of the business potentially in jeopardy.
Regardless of the path you choose, business owners will have the most success when they know the true value of the business and use it to create a comprehensive succession plan. That way they have a better chance of making sure the value drivers of the business are optimized and those poised to take over the helm have the funding to do so.