Thinking About Transferring Your Company To Insiders
In the previous issue of this newsletter, we began a discussion about issues owners should consider before they decide to embark on a transfer of their companies to insiders (co-owners or key employees). We suggested that you:
- Learn About the Transfer to Insiders
- Test Your Assumptions
- Make No More Promises
- Consider Age of Key Employee Group Members
(Please e-mail firstname.lastname@example.org for a copy of previous issue.)
Let's look at a few additional issues that you should consider.
Examine Your Risk Tolerance
Do you want to reduce your exposure to risk as you depart? Many owners decide that the KEG's privilege of purchasing, at a bargain price, the company's stock should be balanced by increasing the risk that the KEG bears. You might transfer risk by insisting that the KEG use its money for the down payment on the initial stock purchase, or that it use personal collateral (such as their residences) as security for any installment note. You might transfer even more risk by insisting that the KEG obtain a bank loan for the entire initial purchase (possibly with the company's guarantee).
Examine Your Successor's Risk Tolerance
How much risk do you want your successor to assume? Are you willing to look exclusively to the future cash flow of the purchased stock for payment, rather than to your successors' other assets? Most owners want their successors (usually a KEG) to feel and bear some of the risk of a downturn in cash flow. They believe that KEG members only become true owners when they bear an element of risk.
Understand the Need for Low Value
Do you understand the need for a low enterprise value in this type of transfer? If selling your company for the lowest enterprise value permitted by a qualified appraiser goes against your grain, you are not alone. It goes against the grain of nearly every business owner. Yet that is precisely the tool owners need to use in order to maximize the money they receive while simultaneously minimizing the risk of non-payment, as well as lowering taxes on the sale. If you are contemplating a transfer to an insider, the valuation number is not nearly as important as developing a projection or model of future cash flow after your departure and as the buyout begins. To be paid, you need to tap into future business cash flow. Placing the lowest defensible value on your company ultimately helps you to avoid excess taxation.
Consider Your Timeframe
If one of your objectives is to leave your company immediately, a transfer to employees is fraught with risk. If, however, you can wait several years to be completely cashed out, a well-designed exit plan can make that happen. Using this longer timeframe not only reduces your risk of not being paid, it allows you time to continually evaluate each member of the KEG to determine which employees are suitable for ownership before you lose control.
Talk about these issues with your business advisors to determine whether a sale to Key Employees is the best exit path for you. If you have questions about any of the issues raised, the advisor who sent you this newsletter can provide more information.
Subsequent issues of The Exit Planning Navigator® discuss all aspects of Exit Planning.