When thinking about transitioning out of their businesses, many business owners would prefer to see their business go to someone they know, such as key employees, partners, or family members, in order to ensure that their legacy continues. Additionally, an internal business transfer or sale may provide a better option for some owners to achieve their financial and non-financial long-term goals.
Selling internally provides some great advantages over an external sale but still requires advance planning and preparation.
Here are 13 key elements to consider when planning for a successful internal business transfer:
- Financial Structure-The internal sale of a business is usually funded via seller financing, the profits of the business, or in the case of a leveraged buy-out, third-party financing. Generally, in an internal sale, the seller does not receive a large amount of cash up front but down payments can be required.
- Value Used for Transfer – Owners may sell their shares internally at market value if the financing and business cash flow are sufficient. However, some internal transfers are governed by strict IRS guidelines, such as Employee Stock Ownership Plans (ESOPs), and gifting and fair market value (FMV) must be used. FMV tends to be substantially less than market value.
- Percentage of Business Typically Sold — Internal transfer options generally allow for a more flexible transfer structure than their external counterparts, offering sellers the ability to sell a small percentage of their ownership up to and including 100% all at once or over time.
- Owner Perks — Depending on the time and percentage of ownership sold or transferred, the perks to an owner can continue during a sale period and be phased out over time. This provides great flexibility to an owner for the continuation of his or her existing benefits.
- Owner Income Stream — The internal sale option provides the most flexibility and greatest possible continuity of income for the owner. An owner can choose to remain involved on a part or full-time basis during the transition and may be able to share in the increase in business value as well.
- Typical Tax Treatment — Some internal transfer options, such as ESOPs and stock redemption plans, can provide dramatic tax savings. Through proper planning, other forms of internal transfers can be optimized to limit the ordinary income tax and receive the more favorable capital gains tax treatment.
- Fees — With the exception of the ESOP, which can have substantial fees due to its complex nature, most internal transfer options do not have substantial fees associated with the transfers. The majority of the fees incurred will be legal, accounting, and consulting in nature. Rarely will brokerage or sell side fees be incurred in these types of transfers since the buyer is already identified.
- Preservation of Legacy – Unlike external sales, the preservation of legacy and the continued employment of current employees and management is generally under the seller’s control in an internal sale.
- Operational Control — Operational control of the business may continue to reside with the transitioning owner in most internal transfers. In the case of an Employee Stock Ownership Plan or a stock redemption plan, the owner can maintain complete legal control over the business for many years if structured correctly.
- Level of Seller Involvement — Seller involvement can vary and is at the discretion of the owners. Most sellers taper down their involvement over time so it does not negatively impact the business and gives their successors the experience they need to eventually run the company.
- Due Diligence — Due diligence is usually limited since the incoming buyer is very familiar with the business and most likely has been involved with the company in a senior position for quite some time.
- Degree of Difficulty of Transition — The internal sale can be a bit easier to accomplish than an external sale but a strong management team must be in place. Planning for the training, education, and development of new leaders takes time and effort. Adequately assessing the skills, abilities, talents, and desires of the incoming team is critical to the continued success of the company.
- Disruption to the Company — The internal sale generally creates the least disruption to the company, typically appearing as a rather seamless occurrence to employees. The culture of the company is generally maintained.
- Impact on Employee Morale — The internal sale can produce a significant positive impact on employee morale. Employees who might have been fearful for their future when employed by a company owned by an aging owner can now be reassured of business continuity. Existing top-level management are generally the successors in an internal sale, and their new leadership role can reenergize a company if they are well respected by the employees.
While an internal transfer is typically less complicated from a business perspective than an external sale, it may be quite complicated from a personal perspective. Most owners will run only one business in their lifetime, and that business is their ticket to financial independence. It is imperative that owners give themselves and others enough time to prepare. We recommend owners begin this process 3 to 5 years in advance of a desired transition.
Owners shouldn’t go it alone, but rather seek proper support to prepare for an internal transfer. Advisors who specialize in business transition planning can help guide you through this process and develop a Business Ownership Transition Plan (BOTP). When done right, a BOTP should align an owner’s goals and objectives with the best sale or transfer options available and provide a comprehensive roadmap to a successful outcome. Having an effective BOTP in place well in advance will enable you to secure the future of your business and ensure that the transition is a positive experience for you, your family, and your employees.