Loading…
888.212.4747
usercard

Tim Cunha JD, BizBen.com ProAdvisor - Nationwide

Selling My Business To My Manager - Creative Deal Structures?

Comments & Feedback From Pro Intermediaries & Pro Advisors On BizBen:

Contributor: Business Broker - Lliquor Stores, Markets, Hotels, N CA
Here are some of the questions that you should be thinking about: Buyout price should be based on the net income; Deal structure should have inventory payments; Price of the business and how should the price be allocated for tax purposes; Priority of payment types are important; Will the Buyer and Seller be working together during the buyout period; What income does the Buyer and Seller expect on a monthly bases; Will there be a promissory note carried by seller if yes, for how many years and what are the guarantees; Will the title be under a corporation, LLC, or an individual; and What happens if business sales decrease over the buyout period.

If the seller does carry a note then if possible they should try to find a bank who can service the note, so every month the buyer gets a statement with how much is owed from the financial institution and not from the seller himself. A seller should inquire with different financial institutions about how much they will charge to service the note, the advantage of this is that new owner will be dealing with a legitimate third party, and less inclined to skip payments because "business is slow".

In selling a small business, the owner has to carefully plan how the income is received in order to minimize the capital gains tax consequences. We can assist sellers in establishing a Deferred Sale Trust that would be particularly helpful in selling a business to existing management; through this method the capital gains tax can be deferred for years, even decades.

The sub-S-Corp gradual purchase structure mentioned by Peter is very effective in accomplishing three objectives:

1. Enabling key employees & managers to purchase the business without outside financing.
2. Transitioning smoothly and seamlessly from one ownership group to another without any loss of momentum.
3. Saving an enormous amount of taxes.

It's very important that the deal be structured carefully with a team of:

a. a business broker familiar with the legal, accounting, tax, and valuation aspects,
b. an accountant who understands complex tax issues, and,
c. an attorney to prepare the essential documents.

A critical factor is how the initial stock purchase is made. Assume that the S-Corp has a total of 1,000 shares issued, all to one owner ("Principal"). The purchaser would buy 1 share and an option to buy 9 shares at some point in the future. As the Principal gradually redeems his shares (20% each year), the proportional ownership of the buyer increases (1/1000 to 1/800 to 1/640 to 1/512, etc.).

Eventually there is enough cash accumulation to redeem all the Principal's remaining shares, except for the 9 shares on which the buyer has an option; so the Principal still owns 90% of the corporation. At this point, the buyer exercises his option and owns 100% of the corporation--10 shares out of the 10 still outstanding. By having the Principal still retaining shares, and particularly, retaining control of the corporation at the end of the redemption activity, the IRS determines that this is not an installment sale and thus the money received for the redemption is tax-free.

Then the the buyer exercises his option to purchase the nine shares and, only then, takes control of the corporation.

I think you can do this in couple of ways. One way is to carry a note for the balance of the purchase price. Usual interest rate is around 8-10 percent, payable in 2-5 years. Other way is to sell share in your corporation. Shares can be purchased little at a time as buyers capital is built. This way, you can have control over your business while being sold to your buyer.

I recommend meeting with an attorney and CPA to structure this deal. Make sure to protect yourself in the event, buyer default on the payment. Most popular retail businesses have a standard gross multiplier, but you can also multiply 3 times your annual adjusted net to come up with the purchase price.

You can always carry back a note/security agreement and file/record a UCC-1 for collateral on the business. A realtor that specializes in business sales would probably have some creative option suggestions.

Contributor: Business Appraisals, Valuations Advisor
Any sale of a business should be based on an appraised value which should include adjusted net profit, asset value and other market influences.

Trying to work out a sale to a manager with little cash can be very risky for you. He may be a good manager but may not be able to handle the job as an owner. Your risk is that he will run the business into the ground and you will lose all your effort in building the business. I have seen a buyer destroy a solid business in less than 30 days.

If your manager can find an investor to give him a 20% down payment on the business he may qualify for a SBA loan. You would get 80 to 90% of the selling price upfront and this would greatly reduce your risk. This same plan would work with any other buyer.

Contributor: Transactional Attorney
If the business cash flow supports it, I'd encourage you to structure a combination of a secured promissory note and a buy out. The advantage to having a secured note is that you may be able to sell it down the line if you ever choose to. It would be difficult to sell your future income from a buy-out arrangement that's based on any form of either sales or net.

I would suggest you not use Gross Sales as a measure of buyout amounts or payments because they may not be tied to actual cash flow. For example, sales could be up substantially, but the business is hit with a large, unexpected cost. Adjusted net is better, but depending on the business may still not accurately reflect actual cash flow in a given month. Ideally you'd use a measure that accounts for the new owner's discretionary expenses, but also recognizes the business' actual ability to pay.

I tend to favor, in order, a mandatory minimum or some other fixed payout structure that is based on a secured (by the Company's assets/tangibles/intangibles) promissory note >>>>> payout based on gross sales >>>> payout based on net income. There are just too many variables that a Buyer, after closing, can inject into the Company's financials that would (theoretically) reduce net income and thereby reduce the proceeds of the sale to the Seller.

A payout on gross sales is fine so long as there is a strong track record and diverse sales pool that is not reliant on any one particular client for say, more than 10-15% of the performance of the Company. I would agree on a neutral, unaffiliated 3rd party accountancy PRIOR to closing that would do all bookkeeping and accounting so there's transparency for the parties on any gross sales payout arrangement.

A secured note is the best situation to protect the interests of the Selling entity b/c if the Buyer defaults the Seller gets the business back and keeps the monies paid to date. We have resold multiple Companies after a Buyer default, so this has worked out well for both our clients and our firm.

BizBen Blog Contributer Buying a Business

Featured Resources, Advisors, & Intermediaries

View All

Popular Blog Posts & Articles On BizBen Today

View All

Popular Discussion Posts On BizBen Today

View All
place a for sale posting
place a wanted to buy posting
sell all Advertising Programs advertisersCTA