In the previous issue of this newsletter, we compared the attributes of sales to third parties to those of transfers to insiders. We looked at the often-overlooked risk involved in third party sales and the equally overlooked benefit of owner control and payoff in insider transfers.
We concede that, without planning and a well-designed strategy, sales are risky whether to a third party or to family members or group of employees. What we hope to demonstrate in this article is that owners can reduce their risk if they (with the help of skilled advisors) carefully design and implement a transfer to insiders.
Here are the essential elements of that strategy that we’ll discuss in more detail in subsequent issues of this newsletter. Of course, if you have specific questions or wish more information sooner, please contact us.
Time. A transfer to insiders takes time—to plan, to implement and to pay for. Typically the more time owners take to transfer the company, the less risk they incur and more money they receive from the new owners. For that reason, the first question an owner must answer is: Am I willing to take time (typically 3-8 years) to execute and complete an insider transfer? If the answer is no, then don’t even consider this type of plan.
Defined Owner Objectives. If owners are willing to devote the time necessary for this exit, they then must define their objectives. These may include:
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Financial security and independence; -
Departure/retirement by a chosen date;
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Keeping the family legacy or company culture intact;
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Rewarding key employees; or
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Taking the business to the next level—on someone else’s dime.
In the well-designed plan, these objectives are met before control is transferred. We’ll talk more about various owner objectives in the next issue of this newsletter.
Cash Flow. Healthy cash flow is critical to any sale. No buyer, (whether outside third party or insider) wants to buy a company with anemic cash flow. In a transfer to insiders, however, cash flow assumes gargantuan importance because it is the sole source, initially, of the money you’ll be receiving.
Growth In Business Value. Like healthy cash flow, buyers look (and pay top dollar) for companies that continue to grow in value. In transfers to insiders, only if value continues to grow does the ownership transfer occur. For this reason, it is vitally important that owners contemplating an insider sale install and cultivate their companies’ value drivers before and during their exit transition. (For a quick refresher on Value Drivers, please contact me for Issue 127.)
Capable management desiring ownership. Having in place a motivated management team capable of replacing you, over time, in business operations is hugely valuable to any buyer. In a transfer to insiders, that management group must also want to be owners and be willing to sign personally for any acquisition financing or ongoing company debt.
Minimize Taxes. No owner wants to pay more taxes than absolutely necessary. In an insider transfer it is imperative that you and your advisors structure the sale to minimize taxes on the company’s cash flow (pre-tax income) Without planning the cash flow is taxed twice—once when the insider receives it (as the new owner) and pays a tax and pays you what is left to purchase the company from you (and again when you pay a tax on the proceeds you receive). Part of tax planning is to have the company’s cash flow taxed but once. Considerable tax planning and structuring is necessary to accomplish this—but it’s worth the time and trouble as it can save a third or more of the cash flow from being taxed twice. This means you can receive more money more quickly and thereby reduce risk of non-payment.
Regulated and incremental transfer of ownership. One of the most important advantages of the well-designed insider transfer plan is that it gives the owner the ability to regulate how, when and the amount of ownership transferred to insiders. If company performance falters, employees stumble or if the owner decides to sell to a third party, the well-designed plan keeps the owner in the driver’s seat.
Control. A fundamental design element of an insider transfer is to keep the owner in control of the company until he or she receives the entire sale price. There are many ways to accomplish this and we’ll talk about many of them in future issues.
Minimize Risk. Business owners take risks every day. They don’t, however, like to put their own and their families’ future financial security at risk. For this reason, good plan design minimizes risk through strategies to maintain voting and operational control in the hands of the owner and shift operational business risk from the owner’s shoulders to that of the incoming owners.
Written Road Map. A successful transfer plan must be described in a written document and communicated clearly (and regularly) to the eventual owners. If the plan is not in writing, it simply is not credible and neither you, nor your employees, will take it seriously. More importantly, the written plan is the playbook for your exit that you’ll use to coordinate your actions with those of your advisors (thus reducing delay and cost). That plan also lays out a timeline and provides accountability—who will do what, when—for all participants, including the owner!
Education (yours) . You need to know more about insider exits because, unlike the sale to outsiders, you will be intimately involved, indeed, you will control the business and the exit process until you’ve gotten all of your dough. That education begins as you read this newsletter.
We will tackle each of these design elements in future issues of this newsletter. Again, if you’d like to discuss any one of them or transfer planning in general, please give us a call.
