Insider Transfers! Ready Or Not!

Transfers to and insiders group appears to be the most   traveled paths for succession planning by business owners today, which are being successfully used by business owners.  

This is the method by default because of the lack of essential value drivers and systems developed by the business owner.  Because of the lack of transferrable value, insiders are the key market for the business owner.   However, it is possible that even though the employees might have the capital to purchase the business, they don’t have the necessary ability to run the business without the owner.   Consequently, this scenario may lead to an inside sale at a depressed value, or the owner becomes a semi-passive owner.   

Typically, The Transfer To The Insider:   

In many situations, the employee will put very little money down, because they don’t have what is needed, or is unwilling to finance a large part of the sale.    The Owner usually will take back paper and finance the sales price.  Typically, the buyer will default because there is not enough cash flow to support the operating expenses and pay the note payment.  

Even with that scenario, there are many employers who take the path of transferring their business to key employees. Even though in many cases the arrangement is ill-fated, and the business will fail.    The actuality is the transfer to insiders is the exit path most traveled by business owners. The point being is that there still needs to be planning done in advance, even if the transfer is two key groups.   

Benefit’s For The Key Group Becoming Owners:  

1. The key group is acknowledged for helping to build the business; The owner wants the key groups to ultimately own the business, especially since they have been part of the success of the business.  

1. Goals of the owner: The owner can see his legacy remain unbroken and his business culture continue. The business represents the owner’s value in the community, and the company’s consistent values.  

1.  It enables the owner to plan their retirement and exit over a longer period of time: Since the process of transferring the business to the key group takes , the owner has the ability to plan their post retirement activities.  It gives the owner the chance to start delegating more responsibilities to the new ownership, testing the group’s ability to run the business. 

1. It gives the owner a chance to share in the excess cash flow to build wealth outside the business.  This helps in transferring the business at, a lower net amount to the buying group, as the owner would have accumulated the wealth outside the business, but with business dollars.    

1. The process of transferring ownership and control to the insider’s takes a period of time, anywhere between five and twelve years. This allows the owner to start adapting to a post business life. It allows the owner to start picking up other activities of interest. It allows the owner to contemplate his new life and start making plans well in advance. This is very important especially if the business owner has only singularly most of his business all his life.  The time gives the owner the ability to create new activities with interest, to test the waters.  

1. Motivates employees: To stay with and grow the company if the owner has a properly planned internal transfer the owner can start this well in advance of their exit. The key employee becomes an owner through their purchases of non-voting stock. This is part of the powerful incentives for the employees to create an increased cash flow. It also motivates talented employees to see the future opportunities in the company, allowing them to stay and grow with the company.   

1. Maintain senior control; The owner will not lose control of his company until he completely cashes out. Usually stock acquired by the employees is non-voting. Employees acquiring   the stock should be asked to sign covenants such as a not to compete, and a non-solicitation agreement. This protects the owner from having the key person leave the company and take customers, trade secrets, and current employees with them.  

1. Flexibility: A properly design transfer plan helps the owner maintain control until the owner can cash out. It gives the owner the ability to abandon the internal transfer so they can sell to an outside company, or a third-party at some point.   All ownership previously transferred would be subject to a buy and sell agreement requiring the employees to offer their ownership to you for repurchase at a predetermined price if the employment is terminated. 

1. Business continuation at the owner’s death. By transferring ownership to insiders, it creates the succession plan should the owner die. The hope is that the key group has been trained well enough, to run the business without the owner. 

CHALLENGES AND LANDMINES! 

1. PUTTING SKIN IN THE GAME: To personally guaranteed the loan necessary to purchase shares. 

1. Is the key employee willing to take the risk of sacrificing a future salary if it requires this? This is a Typical attitude of an owner about keeping their business afloat. 

1. IS THE BUSINESS READY TO RUN WITHOUT YOU?  It’s important for the owner to wean themselves off the dependency of the key group to give them a chance of successfully running the business.  

1. ARE YOU READY TO EXIT FROM THE BUSINESS?  Some owners haven’t put much thought into retirement or exiting their business. Sometimes owners will design the transfer to avoid taking risk, as they can stay on longer, giving up more tasks overtime, so that they feel the incoming owners are sufficiently ready to run the business.  

1. NEW OWNERSHIP NEEDS TO BE TESTED. It’s important that when you do leave the new ownership is ready to run the business. Not as important as when you start the process, but the employee must have the capability in the future to run the business. This is important to observe in the process of training to make sure that they are developing as a business owner. 

1. IS CASH FLOW IN CONSISTENT?  Cash flow is always a factor for an inside sale. If the business has an inconsistent cash flow the business might not be a good candidate for an inside sale. That is not as important if the owner will be a passive owner. However, if cash flow is inconsistent it might not support the financing part of the sale to the new group.   

1. WHOSE MONEY ARE YOU USING TO BUY YOURSELF OUT? The owner is recycling their company’s money to buy out themselves. It’s a means to an end.  Or, they can stay on as long as possible, long enough to acquire the earnings needed to attain financial security, then shut the doors.