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Sales to Co-Owners or Key Employees: The Disadvantages 

Submitted by John Brown on Fri, 01/29/2021 - 8:00am

In the previous article, we examined the main reasons owners choose to exit their companies via a sale to insiders. Today we look at the other side of the coin: the disadvantages. 

Owner’s Financial Security 

Owners may receive little or no cash up front. The buyer’s source of funding, at least initially, comes from the future earnings of the business after the transfer begins. If business cash flow is inconsistent or does not grow as projected, this transfer may not work or take longer than planned. 

The Time Factor 

It takes owners longer to exit using this path than other paths if they want to maintain control until they are fully paid (which we strongly suggest). This is a huge hurdle when an owner needs to exit immediately. It usually takes longer to get paid than it does when they sell to a third party. As is true in a transfer to children, a longer buyout period exposes the owner to a longer period of general business risk. 

The Time Margin 

Owners run the risk of spending more time than they may wish on developing the ownership and management skills of incoming owners. If there are multiple incoming owners, any squabbles or conflict will likely require the owner’s time and involvement.

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Tax Consequences 

Without proper planning, the tax consequences of this type of transfer are significant. Paying unnecessary taxes also negatively impacts the company’s cash flow. 

Achieves Owner’s Values-Based Goals 

There are normally no disadvantages to an owner related to attaining values-based goals unless the successors want to take the business in a different direction. 

Successor 

Key employees, unlike co-owners, are often employees because they don’t have an owner mindset. They’re not entrepreneurs, they don’t respond well to the challenges and pressures of ownership, and they don’t want to risk their personal collateral as guarantees to secure the financing necessary to purchase ownership.   

Benefit to the Advisors  

The benefits to advisors in discussing possible disadvantages in this and the other exit paths is straightforward: it aligns your interests with the owner’s. That’s why we call our version of Exit Planning “owner-centric planning.” This will in turn create a strong relationship with your business owner clients when they can trust you and you can share the same goals.  

As we noted in the prior article, there are several benefits to advisors who help their clients transfer their businesses to insiders, but we must be able explain the disadvantages of this exit path as well. Only then can our clients make an informed choice of the exit path that best meets their goals. 

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