If you are looking for a sale that will result in the most up-front cash and the greatest return on the sale, it will likely be to an external buyer. But what if your priority is to remain a staple in your local community? Do you have other family members that you would want to take over the business? If so, do you plan to gift the business or purchase the business at fair market value? Let’s take a look at all of these options below.

External Buyer

If you are looking to sell to an external buyer, you have two options: Strategic Buyer or Private Equity Investment. External buyers typically have platforms in place; therefore, they will have potential add-backs to generate a higher Earnings Before Interest Tax Depreciation and Amortization (“EBITDA”), and ultimately a higher sales price for you the seller. The sale to a private equity group also could allow for the owner to maintain a minority ownership and active responsibilities within the business, if they so desire. However, it is important to know that the minority interest being retained will likely be diluted based on the private equity group’s preferred stock and related dividends. Also, in order to comply with public accounting principles, it is very important to quantify the consideration transferred. It could be simply cash, but oftentimes, there are additional layers to consider.

Employee Stock Option Plan (ESOP)

In an ESOP, Companies set up a trust fund for employees and contribute cash to purchase the company. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan. Contributions to the plan are tax-deductible. Employees pay no tax on the contributions until they receive the stock when they leave or retire. They then either sell it on the market or back to the company. Under certain specific criteria, the seller of the Company to an ESOP can defer capital gains taxation on their gains by reinvesting in securities of other companies.

Pros and Cons of ESOPs
Pros Cons
  • Seller has opportunity to be a legacy in the community by maintaining the Company’s culture.
  • Seller receives a fair market value, as opposed to a synergistic value.
  • Seller may retain in control of the company (CEO or Board member).
  • Seller may not receive all cash up front and inherit a promissory note.
  • Seller creates opportunities for deferring taxation on its gains.
  • Highly regulated by Department of Labor and IRS.
  • Allows transition period to assure management team is in place to continue operations at a high level.
  • Requires an annual valuation.
  • ESOPs typically make the Company a great place to work and improve employee morale and motivation.

 

Sale or Gift of the Business to Family Members

As is the case in all transactions, for family owned businesses, it is important to be honest with the seller. If there are no specific family members  prepared to take over the business, that should be directly communicated to the seller. So many times, we see the second or third generation inherit a business, but they are not prepared to manage the business effectively. However, once the seller has identified family members who are prepared to take over the business, it is equally important to begin succession planning and transferring ownership interest of the business to the appropriate family member(s). This process allows for the seller to begin transferring responsibilities to the appropriate family members and reducing the potential estate tax burden placed on the family members. Gifting a minority ownership offers the seller a tax strategy for estate planning as the receiver of the gift can apply discounts for lack of control and liquidity, which helps reduce the seller’s lifetime exemption from federal gift taxes.

Conclusion

In closing, if you are a seller and this article applies to you, you have built something special and you should be proud of that. But you should also begin your succession planning today and begin to understand the value of your business and what the best option may be for you. LBMC would love to chat with you and assist you in all the many steps that go with selling a business.