Transfer Options Beyond The Outright Sale
Jul 19, 2010
Transfer Options: Beyond the Outright Sale
It’s nice to have options. Haven’t we all heard that before? It’s something many business owners would probably say and sigh with relief when they realize that ‘selling’ a business isn’t the only way to exit that business. In this article, we’ll dispel this myth and talk about the many options available to exiting business owners.
Today, a large number of Baby Boomer business owners face the challenge of meeting their retirement needs with illiquid wealth tied to their privately-held businesses. According to an NFO WorldGroup study performed in 2002, the number of business owners planning to retire was expected to increase from 50,000 per year in 2001 to 750,000 per year by 2009. Now, more than ever, it is crucial for owners to become educated about their options.
There are primarily seven (7) different options by which a business owner can transfer the interests in a privately-held business:
· Outsiders (owner retires)
· Outsiders (owner stays)
· Initial Public Offering
Employees & Family
Liquidity is the primary concern when considering a transfer of a business to employees or family. One might naturally believe that these individuals don’t have the financial wherewithal to buy out the owner. Whether or not this is the case, it doesn’t have to limit the succession planning process. Take a look at the following options:
ESOPs Provide Tax Benefits
An owner may transfer shares to employees, through an Employee Stock Ownership Plan (ESOP) without the employees ever contributing any money to the owner’s exit strategy. Their liquidity simply isn’t a factor. Furthermore, since 1974, Congress has supported ESOPs by way of tax incentives. These incentives make an ESOP an attractive Exit Vehicle for an owner–even if the owner has no true desire to help their employees.
Estate Planning Within an Exit Strategy
Regardless of their liquidity, family members can in fact play a key role in an owner’s business exit. If an owner has provided for his financial needs independent of the business, he can gift shares of the Company to family members. Over a long enough period of time, these gifting programs can coordinate with an estate plan to manage estate taxation. In addition, transfers to family members can occur in a fast growing business through a Grantor Retained Annuity Trust. These powerful estate planning tools can provide significant tax savings to the exiting owner.
A Leveraged Buyout Option
Employees and Family Members can also utilize the existing assets of the Company to construct a Leveraged Buyout of the owner’s interest. In this scenario, the Company takes on more debt and therefore more risk to accomplish the transfer. If the employees and family members are willing to assume this risk, the owner can make out quite nicely.
The existence of more than one owner creates yet another option. This ownership structure often comes with a Shareholders agreement. The Agreement dictates the terms by which one owner may purchase the interest(s) of the other owner(s). These interests often have a pre-determined Value. A co-owner transfer makes for a clear-cut transaction, as long as the pre-determined Value meets the exiting owner’s Goals.
Outside Buyers will generally pay the highest price to an exiting business owner. The higher up front Value takes into account all possible synergies of the deal (i.e. economies of scale provided by the Buyer, back office savings, cross-selling opportunities, etc.). Most often in this scenario, the owner will sell to a competitor and leave the business entirely.
What about the owner who wants to sell to an outsider without completely leaving the business? Good news—this owner has yet another option. With the intention of using Capital and Management to improve the operation, a Private Equity Group can buy or invest in the Company. This is an attractive option for the owner who wants to keep a hand in the business since The Private Equity Group often asks the owner to ‘stay on’ and run the business. Both cash and shares are offered to motivate the owner, thereby meeting his financial goals and allowing him to keep his ‘job’. This option can present the best of all worlds.
Larger companies, those worth $100mm or more, can offer their shares in an Initial Public Offering. This type of transaction allows the ‘general public’ to purchase ownership in the Company. In turn, the Company accesses ‘public capital’ and its shares trade on a public exchange. When considering this option, an owner must assess the public company costs. The business will need to spend the time and money to report to its shareholders, which can sometimes lead to a short-term mindset. Nonetheless, this option can provide the owner with a high level of liquidity.
Isn’t it nice to have options? It isn’t necessary for a business owner to simply ‘sell’ the business and walk away cold turkey, unless of course, that’s what he wants. After examining our brief discussion of transfer options, an owner can begin to ask questions that will lead to an Exit Strategy that meets his or her personal Goals.