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Business Succession Planning - The Key to Profitably and Confidently Passing Off the Baton Part 3

by Jeff Roberts posted Jul 18 2016 2:22 PM

In our last two Newsletters, we presented the first two articles of a three part series of articles discussing Business Succession Planning. This is the third part of that series.

Five Ways to Transition Out of Your Business

As a business owner, you should never neglect business succession planning because, like your estate plan, you may need it at a moment’s notice. Generally, you can exit your business in two ways:

Voluntarily: You transfer ownership of your business because you want to retire.
Involuntarily: You die or become disabled and your business is liquidated to cover your expenses.

With competent advance planning, here are 5 ways you can transition from your companies – and the challenges you face.


Option #1: Transfer your business to your children.

This is usually done by transferring ownership of the business to your children or other family members by gift, sale or inheritance. Here are the challenges you face:

1. Do you want to leave the family business to one or more children who work in the business? What about your children who are not involved in the business?

2. Do you have enough assets to leave the business to the children working in the company – and leave other assets to the children not involved in the business?

3. What is the perceived value of your business to the children who work in the business? And to the children who are not involved in the business? Determining the value of the business to satisfy all of your children may be more challenging than it first appears.

Many owners want to transfer the ownership of the business to the children now or after their death, preserve their present lifestyle, treat the children fairly and maintain control over the business.

The children buying the business want to use their energy to expand the business and take risks. And, as they gain control, they want to be paid for their efforts. The in-business children want to treat their siblings fairly; still, if they don’t work in the business, they don’t want them to share in its growth.

In addition, the children don’t mind paying their parents a salary, as long as the parents continue to actively take part in the business growth.

Option #2: Transfer your business to co-owners.

As the owner, you may not be as comfortable transferring the business to co-owners or employees as you are transferring it to family members. You may want to maintain control until you retire – until you die – or until you receive full payment. Also, you may want the option to take back your company if you don’t like the direction it’s heading. What’s more, you probably want a sizeable down payment at closing and to maintain your present lifestyle, without personally guaranteeing the loan.

As the buyer, your co-owners’ objectives are like those of your family’s. They want the business to expand. They want to transition into taking control. Eventually, they want to pay themselves handsomely for their efforts. And they don’t mind paying you a salary as long as you actively take part in the business growth.


Option #3: Transfer your business to an outside third party.

Selling your business to an outside party can be an advantage for a number of reasons. But in today’s marketplace, that’s not always realistic. Here are a few of the issues you face, which your advisors can negotiate for you on your behalf.

Earnouts: As the seller, you may find that part of the purchase price will be paid to you at closing, with another part of the price to be paid later based on the future performance of the business. This practice, called an earnout, is fraught with complications for both the seller and buyer. Make sure you are satisfied with the amount of cash you receive at closing and consider the earnout an added bonus. Otherwise, you could be in for a big disappointment.

Escrow: As the seller, you may find that the buyer wants a portion of the purchase price to be held in escrow for one to two years to ensure that you have lived up to the representations and warranties in the purchase agreement. This provides the buyer with a ready source of cash if your representations are not true.

Tax Planning: Another area that can be costly is how you handle the money you receive from selling the business. Often, sellers make tax planning decisions long in advance, such as changing their permanent residence to states with low or no income taxes.

Employment Agreements: You may find that the buyer wants you to remain with the company during a transition period. Or perhaps run the business for two or three years. This is often a deal-breaker if you and the buyer can’t agree. Whether you stay on – and for what period of time – should be negotiated early in the process. Because if you can’t agree, you have no need to negotiate further.

Noncompete Agreements: It’s entirely possible that they buyer will expect you, personally, and perhaps some of your key employees, to sign noncompete agreements. Often, these agreements may bar you from this type of business for as long as five years. Your lawyer should help you negotiate a narrow noncompete agreement with as few limitations as possible.

Unlimited Liability/Personal Guarantee of Representations and Warranties: Your buyer may insist that you have unlimited liability on the representations and warranties in the purchase agreement. Your advisors will do everything possible to limit your liability for these conditions. Part of the buyer’s protection will come from money held in escrow for this purpose. This is a key provision that your advisors will negotiate on your behalf.

Many other issues exist that your lawyer and CPA will discuss with you at the appropriate time. The issues discussed here merely touch on the many ways competent advisors can protect you during and after the sale of your business.


Option #4: Transfer your business to employees. You may have one or more key employees who are ambitious and capable of running the business. Seldom will they have the capital needed to obtain adequate financing for the purchase. Likely, you will have to provide financing. Another alternative for companies with more than fifty employees is to create an Employee Stock Ownership Plan (“ESOP”). With an ESOP, you will also have to retain some equity stake in the business for a period of time to induce a lender to furnish the debt for the acquisition.

Option #5: Liquidate your business’s assets. In most cases, this is not a good option because sellers rarely get the amount of money they deserve. And with so little cash left over, your dependents must find other sources of income during the time the assets are being sold. Use this only as a last resort.

You’re Invited to Call or E-mail. 

“If you have questions about owning and operating a business, please send your e-mail to

jeff@robertslegalplanning.com or call me at 618.639.0461.

I’ll be happy to help you in every way.” -- Jeff

 

Jeffrey D. Roberts

Attorney at Law w CPA w Entrepreneur

 

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