Five Remaining Elements of Planning for a Successful Sale to Insiders
The prior article dealt with the first five elements which should be part of a business owner’s plan to successfully transfer his or her company to “insiders” (family members, key employees and co-owners). They were: Time; Defined Owner’s Objectives; Business Cash Flow; Growth in Business Value (using Value Drivers); and Capable Management Desiring Ownership.
This article deals with the remaining five elements of planning for successful sales to insiders that keep owners in control of their business until they are paid the entire sales price.
Element 6: Minimizing Taxes upon Sale.
While no owner wants to pay more taxes than absolutely necessary, those contemplating insider transfers must focus on minimizing taxes. In insider transfers, it is imperative that the owners and advisors structure the sale to minimize taxes on the company’s cash flow (pre-tax income) because, without planning, the cash flow is taxed twice—once when the insider receives it (as the new owner) and then pays taxes before paying the prior owners to purchase the company; and again when the prior owners pay taxes on the proceeds they receive.
One goal of tax planning is to subject the company’s cash flow to taxation only once. Accomplishing this feat takes considerable planning, but it’s worth the time and trouble to save a third or more of the cash flow from this type of double taxation. One-time taxation means owners receive more money more quickly and thereby reduces risk of non-payment.
For instance, owners who include in their plan to transfer ownership to insiders a deferred compensation plan payable to the owners directly by the company pursuant to a deferred compensation agreement pay only one tax (though at ordinary income tax rates instead of capital gains tax rates).
Element 7: Regulate an Incremental Transfer of Ownership.
One of the most important advantages of the well-designed insider transfer plan is that it gives owners the ability to regulate how ownership is transferred, when it is transferred and how much ownership is transferred. If company performance falters, employees stumble, or if the owners choose instead to sell to a third party, the well-designed insider exit plan keeps the owners in the driver’s seat.
Element 8: Increased Control = Decreased Risk to Owners.
While business owners take risks every day, they don’t relish risking their own and their families’ future financial security. Therefore, it is advisable to use strategies to retain voting and operating control in the hands of the owners and shift operational business risk from the owners’ shoulders to that of the incoming owners, so that owners stay in control of their companies until they receive the entire sales price.
There are many ways to accomplish this. For instance, one way is to recapitalize the common stock of a company into two classes with one class being Class A Voting Stock consisting of one percent of the total shares (and total value of the company), and the other class being Class B Non-Voting Stock constituting 99 percent of the total shares and value of the company.
Owners can retain voting and operational control by first transferring all Class B Non-Voting shares to the insider and then only transferring the Class A Voting shares once the insider has paid the full purchase price.
Element 9: Written Road Map with Deadlines.
To succeed, it is highly advisable to put a transfer plan in writing and communicate it clearly (and regularly) to the eventual owner(s). If the plan is not in writing, it simply is not credible and neither the business owners, nor the employees, will take it seriously. More importantly, the written plan is the playbook for the business owners’ exit that will be used to coordinate actions with their advisors (thus reducing delay and cost).
The plan should include a timeline and provide accountability—who will do what, when—for all participants, including the owners! Use incremental, staged checkpoints. As they say, you’ll never finish a marathon if you don’t have mile-by-mile goals to meet.
Element 10: Education (yours).
Experience tells us that owners need to understand the ins and outs of insider transfers because, unlike sales to third parties, owners can control the business and the exit process until they are paid the entire sales price for the business. As a business owner, that education began the moment you started reading this article! Thanks for listening!