When you start to implement your Exit Plan, you need to consider who will succeed you. You can sell to a third party, transfer to an insider (key employees), or transfer to a child. Today, let’s focus on a transfer to an insider. The transfer of ownership to an insider can be difficult and risky, but it can be done and it can me rewarding to all the of the stakeholders.
3 Risks to consider when transferring your business through and Inside Transfer:
Creating a plan that helps minimize risk gives owners the best chance to reap all of the benefits of their transfers. Let's look at some potential ways to address each of these issues.
1. Insiders (i.e., key employees) have no money. Therefore, it is too risky to sell to them. This is true if owners don’t design a transfer strategy that puts money in the key employees’ pockets as they increase business value. Cash flow must be steadily and effectively built through the installation of Value Drivers and careful planning to minimize taxation, years in advance of the transfer.
Additionally, cash flow can be taxed twice unless owners carefully plan to avoid it. This double tax (sometimes totaling more than 50%) can spell disaster for many internal transfers. Through effective tax planning, much of this tax burden can be legally avoided.
Finally, owners and their advisors (including a certified business appraiser) should use a modest but defensible valuation for the company. When a reduced value is used for the purchase price, the size of the tax bite is correspondingly reduced. The difference between what owners will receive from selling their businesses at a lower price and what owners want to receive after they leave their businesses is “made good” through several different techniques that extract cash from their companies after they exit.
2. Successor’s management/ownership skills are untested. If that’s the case, owners and their advisors must create a written plan to systematically transition management and ownership responsibilities to the chosen successor, beginning today. The transition period during which assumptions and the successors’ skills can be tested usually takes several years to complete.
3. Business owners lose control before being cashed out. This is only true if owners and their advisors fail to implement a transfer strategy designed to cash owners out before they lose control. In successful insider-transfer plans, owners keep control, in part through a well-designed and incremental sale of the company, and are cashed out based on improving company cash flow.
The keys to reducing the risks of an insider transfer are:
For more information about how we can help you design and implement an Inside Transfer Plan, please go to our website CORE Strategic Business Solutions.
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To assess your business related to the key elements of successfully transitioning your business, please complete our Comprehensive Transition Assessment