Avoiding the pitfalls when transferring your business to someone you know & care about
The allure of cashing out of your business while leaving it in the hands of a trusted business partner, employee, or family member seems like the perfect scenario. Accomplishing such a goal is aspirational and can often be the key to the continuation of your business in your local community for decades to come. As advisors to families who own a business, we see this desire quite often, but unseen perils lurk in the shadows. This article can serve as a guiding light to help you down the potential paths to internal transfer success.
Sounds great! However, the question remains - what could derail the plan while there are good intentions and tangible benefits to transfer the business internally?
#1: Insiders have no money
While this is almost always the reality, owners must design a transfer strategy that puts money in the insiders’ pockets as they increase the value of the company. Owners must work steadily and effectively to build corporate cash flow (the source of all cash outs) through (a) the installation of Value Drivers and (b) careful planning to minimize taxation years in advance of the transfer. Just like a sale to a third-party buyer, there must be adequate cash flow for this to be a viable buyout option.
#2: Tax surprises
It’s all too common for owners to discuss gross proceeds of a business sale: “I heard Johnny sold his engineering firm for $7 million and Jim sold his construction company for $12 million.” While gross numbers are great for bragging rights, they never tell the whole story. The value of having an accurate forecast of payout timing and proceeds after legal & valuation fees, as well as payoff of all outstanding corporate debt, is crucial. Is there going to be a sale of assets or stock? Is there a reason to convert from a C Corporation to an S Corporation, or even from S to C? Without careful planning, cash flow can be taxed twice and total more than 50% of the payout.
The discussion and analysis of all potential exit routes with legal, financial, and tax experts is paramount for confidence in the process. Proper consideration of all potential transfer options can help lead to a smooth execution, reduced impact of taxation, and the lowest reasonable chance for regret by either party, therefore avoiding a potential busted deal.
#3: Successor’s ownership skills are untested
If the buyer’s skills as an owner are unknown, the seller should create a written plan to systematically transition management and ownership-type responsibilities to their successor, beginning as soon as possible. The transition period, during which owners test both their assumptions and their successor’s ability to get the job done, usually takes several years to complete and provide adequate confidence to both parties.
#4: Loss of control before being cashed out
This could happen if owners and their advisors fail to implement a transfer strategy designed to keep the owner in control until he or she receives the full sale price for the business. In a properly crafted plan, owners keep control through a well-designed and incremental sale of the company based on improving company cash flow over time.
A potential transfer catastrophe is only that: potential. Understanding these issues will allow for an Exit Plan that is capable of evading these pitfalls and stress-testing your plan over time will give it the best possible chance of success. The transfer of your business is likely the single most important financial transaction of your life. Put forth the effort to chart your course now. You
won’t regret it.
There are many advantages to transferring your business to an “insider” if there is sufficient time, talent, and desire to develop a plan:
Retains the legacy you set out to create
Control of the transfer timeline
Retain operational control & decision-making
Ability to sprint, or saunter, off in to the sunset
Continue to share in ongoing equity growth
Motivate and reward key employees
Ultimate flexibility to achieve your goals as owner
ABOUT THE AUTHORS
Randy Ward, CFP®, CExP™ and Tim Watson, CFP®, AIF® head up the Exit Planning team at Strategic Financial Partners here in Colorado Springs and work through their 7-step exit planning process with business owners to game plan for an eventual exit. By acting as the quarterback of the Exit Plan, it allows them to know the need for subject-matter-experts and facilitate that part of the plan when needed, such as utilizing valuation experts, attorneys, ESOP specialists, and M&A consultants to help make sure your goals are achieved.
Financial Advisors do not provide specific tax/legal advice and this information should not be considered as such. You should always consult your tax/legal advisor regarding your own specific tax/legal situation.
Randy Ward, CFP®, CExP™ and Tim Watson, CFP®, AIF® are Registered Representatives and Investment Advisory Representatives, Securian Financial Services, Inc., Securities Dealer, Member FINRA/SIPC, A Registered Investment Advisor. Strategic Financial Partners is independently owned and operated. 1755 Telstar Drive Suite 501 Colorado Springs CO 80920 2364465 DOFU 01-2019
Separate from the financial plan and our role as financial planner, we may recommend the purchase of specific investment or insurance products or accounts. These product recommendations are not part of the financial plan and you are under no obligation to follow them.
Strategic Financial Partners specializes in creating and developing quality relationships with our clients by providing coordinated financial solutions to help clients reach their personal and business goals. For more information on becoming a financial advisor, please visit our website: www.sfp.us