Selling your business to a key employee, or a group of employees.
Assuming that all of the purchase price is to come from the key employee (s), you can help the purchase, by (a) using a stock dividend distribution, or (b) bonus of money to the employ, such as a bonus executive program. (See Restricted bonus agreement).
It is important that the company have consistent cash flow, (discretionary cash flow;) to use for this purpose. (This is the cash generated by the company which is not needed to run the operations, for debt service or capitalization of the business).
Planning for the sale of the stock to insiders, and cash flow;
It is important to have a accurate idea of the yearly cash flow. For example, if the discretionary cash flow is $1 million a year. You might commit 10% of the company, or $100,000 a year to help pay for stock.
If discretionary cash flow is not available, and the key person (s) doesn’t have the money to purchase the stock, then you might consider other methods for the sale. For example, passive ownership, or arranging to have a deferred compensation payment along with a company pension plan. The deferred compensation plan can be funded by corporate dollars. The payout could match what you would sell your business for. There is always the possibility of using both methods. Although the key group or key person may not be ready to become an owner today, there is a possibility of the key man growing into that position over time or finding someone new. The most important thing is to set up your planning in advance.
It also suggests that you consider an outside sale, or consider the timing of your exit. By planning early, you can set up the systems needed to put yourself in the position of making the choice and having your key people prepare themselves for the sale and exit.
Most of the time the key group will not have the money to purchase the stock, and it’s your company that usually will fund your exit plan, either by a cash flow, or a benefit set up for you such as a deferred compensation. In some cases, with proper planning you can also use the discretionary cash flow to arrange benefit for you as an owner which will fund your retirement on a guaranteed basis using company money. Consequently, if you don’t find the right buyer, or get the value of your business, you can sell for less, knowing you have a great benefit you will receive either way.
Paul started an instrument development company 25 years ago. Over the years he put must of the money into the company, and never took a larger salary. Over time he built the business up to the point where he had consistent cash flow and profitability yearly.
His son came in the business and started to take over the duties of the company. Paul put much of his profit into the growth of the company, consequently, he never created wealth outside of the business. His dream was to give the business to his son. However, to do that he would need the value of the company in order to retire.
To avoid selling the company to his son, Paul set up a defined benefit pension plan for himself and a few others in the group. The large percentage of the contributions went into Paul’s account. Consequently, the contributions were tax deductible by the company, and created a known income for Paul when he retired. This allowed the company to contribute huge amounts of tax deductible contributions for Paul’s account, creating a guaranteed income for his retirement. The income represented what he felt he could sell his business for.
Because he was planning in advance, he was able to retire, and give his business to his son. This was all done because Paul used his discretionary income to create some type of wealth, and he also started his planning early.