Business owners who have the ability to hire, train and retain excellent employees do themselves a great favor when it comes time to sell their business. Recruited employees who sign on to the company culture, are potential purchases of the company. They get involved in all aspects of the business when given the chance. The ability to nurture these employees not only creates a great long-term employee, but possibly future owners of the company. The investment in good employees has the by-product of creating a potential market for the business owner’s business.
Over time, these owners can create employees who become extremely loyal, and feel part of a group and the business itself. They observe how the current owners treat the business, the employees, and learn the long-term elements needed for a successful growing business. They become clones of the current ownership, and start to think like owners, while taking on more responsibilities.
While the owners at some point need to make the commitment to the potential employee(s) purchaser to sell the business to them, it also means the employee or employee group needs to be able to commitment to the purchase of the business. To the purchasing party, this means committing to taking on risk and financing for the purchase of the business. In most cases this is something they never have done before.
The commitment to sell the business to key people, or key person is a long-term process. The owners have to make sure the key person (s), have the ability to think like employees, and the abilities to run the business with expectations of the company being profitable. The owners will spend time training and assessing the abilities of the key group to prepare them for the business takeover There is a commitment on both sides as to arranging this type of sale.
Financing the Sale:
A sale of the business to an outside group usually is a cash sale. Or, a combination of cash and stock of the new owner. (Usually when a larger company buys a smaller company).
It is here that the advisors need to make sure the selling owner maximizes his sales with tax efficient transactions. Many business owners sell their firms only to be surprised at the after-tax results of the sale. Keep in mind that when you sell the business, usually there is a low-cost basis, the consequence paying higher taxes on the gain, means less net profit!
If it is an asset sale, there may be a low-cost basis of the assets being sold, consequently creating more tax exposure, and more taxes.
Take for example, an asset being sold after it has been depreciated, it may be taxed as ordinary income. Usually the asset is owned by the corporation. If the company is a C corporation, the sale is taxed at the corporate level, then taxed at the personal level. The combination of a low-cost basis, C corporation tax, ordinary tax rates, and double taxation can erode gross profits to a point where the owner wonders why they sold the company for the next.
If the owner sells their company to a publicly traded company, and takes back some of the purchaser’s stock, there should be pause as the consequences should the stock value fall because of the transaction, and the uncertainly of the value when the selling owners wish to cash out.
It has happened more than once when selling owners, ended up with much less in their pockets after the taxes and expense of the sale were taken out!
Selling to a key group or a key person is usually a different arrangement. Usually the employee does not have the financial ability to purchase the company, thus a loan from the small business association or bank is needed. Sometimes, the employee comes up with money by refinancing their home or borrowing from the family. In many cases, the selling owner usually takes back a note expecting payment from the cash flow of the business. It’s common to have a combination of refinancing, a promissory note, and possible deferred compensation payment to the selling owner. In any event the selling owner usually has some skin in the game as to the financing of the sale. Because of owner financing, the ultimate payoff might be extended over a longer period of time. Not necessarily a bad thing, as the owner can spread the tax liability over a period of time. The owner will also have a security interest in the stock, assets, and receivables of the company, until the loan is paid off.