Kathy Richardson-Mauro
Business owners generally believe the only way to monetize their business transition is via a third party sale. While this may be one option, it is not usually the only one. The external sale may, however, become the default option if an owner fails to properly prepare and plan for the eventual business transition. Once an owner experiences a life event, such as a sudden illness, a disability, a family crisis, or the loss of a key employee, it may eliminate the time needed and limit the opportunities to monetize any other way.
Owners also often believe that the third-party sale is the best way to minimize their financial risk since they can receive their cash all at once upon closing. This may be appealing to some owners who do not want to consider any type of a long-term, protracted sales event, which might require seller financing and continued risk on their part. Still, other owners may not have saved sufficiently outside of their business and need to access the illiquid wealth trapped inside their business to fuel their next phase of life. However, even if the bulk of cash is received at closing, after taxes and fees are paid, it may produce less than required for their needs post-transaction.
If you read our blogs or whitepapers such as our Guide to Selling Your Business Externally, you will learn there are many things to consider about an external sale including the non-financial aspects of a transition as well as the potential taxes and fees, which can account for an enormous reduction in the net proceeds received. Deal structure and tax minimization are every bit as important as price, possibly more so.
Other than the external sale, what methods exist to monetize a transition? Here are just a few:
- Leveraged Buy Out (bank financed)
- Management Buy Out ( seller financed)
- Employee Stock Ownership Plan, or ESOP (bank or seller financed)
- Stock Redemption (no debt required)
- Gifting (no debt, no liquidity)
- Charitable structures (no debt)
In fact, we have found many owners would actually prefer an internal sale to management, employees, or family but believe that this option is not possible since it may not provide the needed liquidity, they do not have a qualified successor in place, and it carries a financial risk of future payment. In fact, often debt is a requirement, either in the form of bank or seller financing, to accomplish most internal transitions and may not offer much in the way of immediate liquidity. However, there is one option, the stock redemption,that does not require debt of any kind. We will cover this option in more detail in an upcoming blog, but suffice it to say for now that it provides some unique opportunities if the correct situation exists and time permits.
These internal options can also potentially net more than the external sale if structured correctly since most offer tax efficiencies and lower transaction costs. Some of these internal methods, like the ESOP, can provide immediate liquidity and minimize future financial risk, but they also require time and planning prior to the transaction to establish necessary succession. It takes time to develop family members or a management team who can assume the ownership role. Also, through the transition planning process, financial risk can be minimized and proceeds maximized.
With so many transition options available, why do many owners opt for the external sale? Often owners do not know they have other options available to them. If the management team has little money of their own or they have no one currently qualified to take over the company, they may assume they have to sell externally. In fact, in some instances with proper planning, an external sale may be the best option, but we recommend that an owner explore all the options available that can meet his or her goals and objectives. This planning, however, must take place well in advance of any life event or transition deadline. When time is not available, the options become fewer. But if there is sufficient time and the proper planning is accomplished, other options, such as the internal options listed above, may prove to be more appealing both financially and non-financially than the external sale. Don’t let the external sale be a default due to lack of planning. If it is the best option, make it a conscious choice by preparing and planning ahead.
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