IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Jane Johnson of Business Transition Academy (www.businesstransitionacademy.com):

Business Transition Options for Privately Held Companies

Owners often believe that when the time comes for them to retire, they’ll simply sell or pass on their business and move on to the next phase of their lives. The reality is it’s a complex process not an event. When considering selling options, owners typically focus on the financial considerations, often assuming that the higher the sales price, the more they will net – but that might not necessarily be the case – 30% to 50% of the sale proceeds could be consumed by taxes and fees. Thinking about selling to a third-party buyer? Did you know that only about 25% of businesses that go on the market actually sell? Or, maybe you want to pass your business on to your children. Did you know that less than one-third of family businesses survive the transition from first to second generation ownership?

The numbers don’t lie – transitioning out of your business is anything but simple. But you can do it successfully with thoughtful, careful planning and ample time, which is why you need to educate yourself about your business transition options and devote time to the planning process.

Let’s look at some of the most common types of external and internal transfer strategies, their broad characteristics, and the types of businesses and owners each one may be best suited for.

External vs. Internal Transfers

There are two general categories of business transfers – internal and external. “Internal” refers to selling or gifting the business to insiders, such as employees, managers, or family members involved in the business. “External” refers to selling to an outsider, such as a competitor, customer, or investor. As you weigh the various options, it is imperative that you understand that different transfer options have different transfer values, including different fees and taxes, as well as different personal and business implications – some of which we’ll touch upon here and in our forthcoming whitepaper.

External Transfer Options

Private Equity Sale/Recapitalization:

Financial buyers, such as private equity firms (PEFs), purchase a majority stake in the business and allow current owners to keep a portion. Leveraging their capital, expertise, and relationships, the plan is to increase business value over three to five years, and resell it with the goal of a large return for all shareholders.

Business Value: Investment or average market value

Funding sources: Debt as well as equity capital

Owner Timeframe: Ideally 5 years

Tax implications: PEF sales/recapitalizations are stock transactions that are typically structured as asset sales. C corporation sellers will pay tax at both corporate and personal levels.

Business and owner suitability:

• Companies with strong growth or growth potential >20% annually
• Owner wants to retain some ownership and potentially get a second payday when company sells again
• Key employees and/or family members who desire or can handle ownership

Sale of 100% of Business to Third-Party:

This type of sale may be to a financial buyer who needs to keep the existing business structure or to a strategic buyer that can realize synergies (reduce operating expenses) and increase profits as a result of the acquisition.

Business Value: Synergistic or highest market value

Funding sources: Debt, equity and/or seller financing

Owner Timeframe: 9-24 months

Tax implications: Most third-party sales are asset sales that result in higher tax for owners. C corporations will pay tax at both corporate and personal levels.

Business and owner suitability:

• Well-run businesses with solid financials and growth potential
• Owner doesn’t have family members or key employees who can or want to run the business
• Owner desires faster payout and shorter timeline for involvement

Internal Transfer Options

Family Transfer:

Owners transfer the ownership of their businesses to their children or other family members by either selling and/or gifting shares.

Business Value: Typically less than market value

Funding sources: Business profits, bank debt

Owner Timeframe: Whatever they wish, but 5 to 10 years not unusual

Tax implications: Can be structured to minimize transaction as well as estate/gift tax

Business and owner suitability:

• Current owner wants the option to stay in control longer
• Family members who think like owners and can be groomed to operate business
• Current owner may have estate tax exposure that is increasing as company grows
• Business that is growing enough to support all generations
• Business may or may not be marketable to outside buyers

Key Management Transfer:

Owners reward loyal managers or employers by selling the business to them over a period time.

Business Value: Typically less than market value

Funding sources: Business profits, bank debt, manager capital

Owner Timeframe: 5 to 10 years

Tax implications: Can be structured to minimize transaction taxes for owner

Business and owner suitability:

• Current owner wants the option to stay in control longer
• Key employees who think like owners and can be groomed to operate the business
• Business is profitable enough to fund buyout if employees do not have capital
• Business may or may not be marketable to outside buyers

Employee Stock Option Plan (ESOP):

An ESOP is a qualified retirement plan that is created when owners sell all or a portion of their business shares to a trust on behalf of all of their employees. Employees earn shares annually that are converted to cash when they retire.

Business Value: Typically less than market value

Funding sources: Business profits, bank debt

Owner Timeframe: 5 to 10 years

Tax implications: Can be structured to minimize transaction taxes for owner. S corporation ESOPs do not pay income taxes.

Business and suitability:

• Current owner wants the option to stay in control longer.
• Culture conducive to having all employees as owners
• Company has at least 20 employees, $3 million in value and annual cash flow of at least $500K

Determining which Strategy is Best for You

Choosing the most suitable transition strategy for your business is not an easy decision to make. There are pros and cons to each type of transfer, and it’s important to assess the different options and figure out which one will accomplish your financial and non-financial goals.

Engaging in the Business Ownership Transition Planning process, guided by experienced advisors, can help you align your objectives with the best transfer options available and provide a comprehensive roadmap to a successful outcome. The more time you give yourself to plan your business transition, the more options you will have, which is the best position to be in as you plan your future.

Jane Johnson is the Co-founder of Business Transition Academy (BTA) and co-author with Kathleen Richardson-Mauro of the book, Cashing Out Your Business- Your Last Great Deal.  Ms. Johnson can be contacted for additional information about this article, her book, or the services offered by BTA at (844) 469-3948 or jane@BusinessTransitionAcademy.com.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.