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Sales to Co-owners or Key Employees: The Advantages

Submitted by John Brown on Fri, 01/22/2021 - 8:00am
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Many owners aspire to transfer their businesses to longtime, hard-working, competent employees, but they don’t know how to do so and neither do their advisors. That’s unfortunate because according to a recent survey of BEI Members, about forty percent of respondents who have engaged in Exit Planning indicated a desire to transfer their companies to co-owners or key employees. In this article, we look at some of the reasons why. 

Owner Financial Security 

You can structure the deal to suit your client-owner’s financial wants and needs and give owners the option of selling the company to a third party at any point along the transfer continuum. You can design the sale process to keep owners in control of the business during the buyout period and until they get all of the money they want and need.  

Co-owners and key employees who one day will become owners are as interested as your client is in building value, training future owners, and making the business more profitable, stable, and better managed. If, before the transfer is complete, owners decide to postpone their exit date or even sell to outside parties, having motivated employees pays off handsomely at the closing table.  

This method of transfer may also yield more income over time than a sale to a third party or Employee Stock Ownership Plan (ESOP). During the multi-year transition period, the continuous distribution of free cash flow to an owner in the form of salary, distributions, and perks can be a source of significant asset accumulation. Owners continue to share in the growth of their companies. When they ultimately cash out, they receive not only the initial business value, but also the proceeds from its growth in value.  

Transfer Plan Flexibility 

It normally takes longer for an owner to phase out of ownership in a sale to co-owners or employees than it does through a sale to a third party or a sale to an ESOP. During that time if something unexpected happens (such as the owner’s sudden disability or unexpected inheritance), owners have options. When correctly designed, this type of transfer permits owners to jump tracks to another exit path, namely a sale to a third party, at any time and for any reason.  

The Time Margin 

Owners have time, usually five to ten years, while receiving income and maintaining control to slow down and develop other interests and pursuits outside of the business. This is especially important when owners are not yet sure of how they want to spend their time after they exit. There is time for key employees and incoming owners to gain experience in running the business without its owner while the owner is still in control. 

Minimizing Tax Consequences 

You can design these transfers to minimize an owner’s income tax consequences. Without proper planning, owners can end up paying unnecessary taxes, which ultimately will negatively impact the company’s cash flow. Therefore, minimizing taxes plays a big part in making sure that owners protect their sales price, exit the business when they want, and reach all their financial and value-based goals for their exit.  

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Achieves Owner’s Values-Based Goals 

An insider is more likely to maintain the culture, legacy, and mission of your client’s business.   

Additionally, the employees who helped build your client’s business keep their jobs. During an inside sale, owners are also able to treat all children equally by (eventually) providing them equal amounts of cash from the sale. This appeals to owners who would rather not worry about which child will run the business and which children will receive other assets (or not) to compensate for them not being an owner in the business. 

Known Successor 

The buyers (co-owners or employees) are prequalified through on-the-job training and observation. 

Properly designed and implemented transfers to insiders are income-tax efficient and allow selling owners to remain in control of their businesses until their goals and aspirations are achieved.  

Benefits to Advisors of Helping Owners Transfer Their Businesses to Insiders 

The benefits of an inside transfer don’t only apply to the business owners. There are also important benefits to advisors who are able to help their clients transfer their businesses to insiders. 

  1. There is substantial, ongoing core professional work for business advisors in implementing a successful ownership transfer from owner to key employees.  
  2. Ownership is typically transferred incrementally over several years during which you can provide ongoing representation.  
  3. Perhaps most importantly, your representation can make a real difference in the lives of your owner clients. 

Advisors who have Exit Planning knowledge as well as access to BEI’s proven designs and tools are equipped to undertake the planning and actions necessary to ensure a successful transfer. If you would like to know more about these designs and tools, please contact a BEI representative.  

Our next article addresses the main disadvantages of insider transfers. 

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