Business Exit Strategies: Part II – Passing on to Others
This is the second installment in a series of exit strategies for business owners. As mentioned in Part I, everything comes to an end eventually and businesses are no exception to that rule. As a business owner, the eventual end to your business (or to your involvement with your business) is inevitable, but you do have control over how that end might look. It is in your best interest to orchestrate your own retirement, sale, merger or response by business to your death. Given that this is the case, it is advisable to make a plan that covers how you would like to dissolve your business or pass it on to new leadership.
Important questions could be covered in this “exit plan”, including:
- How long before you take your exit?
- How much money, if any, do you plan to make personally when you exit?
- What would the transition period look like?
- Will your business continue under new ownership or dissolve after you leave?
There are a number of ways to prepare your company for your exit. In this part of the series, we outline the advantages and challenges of passing your business to relatives as part of an inheritance or partnership transfer. We also discuss the possibility of a management or employee buyout of the business.
Exit by Inheritance
For many small and medium business owners, keeping the business in the family for multiple generations may seem like the best way to preserve your name in the business, it’s important to be practical about who is really the best person for the job of running your business.
Passing a business to the next generation can be challenging. Indeed, despite much more desire to see businesses carried on in the second generation, only 30% of businesses actually continue past the first generation according to the Family Business Institute.
Moving your family business into the hands of the next generation properly requires the help of a knowledgeable legal expert. The techniques available to pass on a company in a way that is tax-friendly and watertight in terms of protecting your best interests all require a lawyer. These include transferring your business shares, structuring an installment sale to one or more family members, setting up a grantor annuity trust or using life insurance as a business contingency tool.
In fact, when done properly a business is better not to be left behind via inheritance but rather through one of the methods above.
“… it is advisable to make a plan that covers how you would like to dissolve your business or pass it on to new leadership.”
Be mindful that even when properly structured, there are still pitfalls to selecting a family member as the heir to your business. First, you may need to convince employees, clients, investors and other stakeholders that the person you selected is the right person for the job. Secondly, involving a particular family member in your business may alienate others in your family, causing familial stress and conflict.
Despite the potential difficulties and complexities, there are clear advantages to passing your business on to the next generation. Being able to select the heir to your own legacy is one advantage and, if your heir is your child, you will have had time to prepare them adequately for the job.
Exit by Transfer to a Partner
One of the simplest ways to transfer ownership of a company can be done if you are the part owner of the business and the person buying your shares is your business partner. This can be done in a variety of ways depending on the circumstances, including whether you are remaining an investor in the business (but stopping daily involvement with business activity), retiring from the business entirely or plan to transfer shares of the business to your business partner in case of an untimely death.
In many cases, planning to exit by transferring your shares to a business partner ensures that the business as you know it remains intact. It also has the advantage of being a transaction with someone you already know and trust – usually making the process easier to manage than other business sales.
Although the process to transfer shares to a partner can be straightforward, it is still not without its difficulties. If not properly handled, the process could end up causing conflicts between you and your partner leading to a range of potential problems. Planning partnership agreements might also be fairly complex. For example, the documentation involved in transferring shares upon your untimely death may involve reliance on making the company a beneficiary of a life insurance policy, then the company uses the proceeds to purchase shares from your heir. The document for such an agreement must be drafted by a lawyer.
Exit by Management Buyout
Looking for a way to maintain your business’ legacy while retaining your key performers as the leadership within the company after you leave? Then you might consider selling your shares to the very employees you have managed during your time as owner of the company. This form of transfer is called a management buyout or MBO.
In an MBO, your managers take over the business’ assets and operations. These are people who have been part of your business and thus are likely to know you well, and they’ll be more likely to want to keep you on as an advisor if you are open to it.
Funding for an MBO usually comes in the form of personal finances of the managers, the assistance of private equity financiers who also take an ownership stake in the company and seller-financing (that is, you accepting financed payments for the transfer of your business to your management team). In some cases, the transfer happens with the help of debt financing by way of collateralizing the company’s assets. This is called a leveraged management buyout of LMBO.
There are some difficulties you may face in attempting an MBO or LMBO. Firstly, you may not be able to find employees willing or able to make a purchase of the company. Secondly, the exposure of the new organization to high amounts of debt financing (in the case of an LMBO) or dilution (in the case of an MBO that is linked to private equity) may result in the company not having as much flexibility as it did under your leadership.
Because of all of the above factors, MBOs and LMBOs can be very complex transactions. It is important to work with an attorney with business experience that can advise on business strategy as well as reviewing documents and agreements.
The Importance of Legal Counsel
When transferring your business to family members, your current business partners or your employees as your exit strategy, it is paramount that you retain experienced legal counsel to represent you. Regardless of the methodology you use, you would require an attorney with extensive business experience to lead the drafting and review of your documents. Your attorney should be well-versed in business brokerage, ownership structures and Florida business law. It is important that you are prepared legally to participate as an equal to other parties who may also have their own legal representation as you consider the future direction of your business.
South Florida Law
The business attorneys at South Florida Law, PLLC are experienced in drafting and reviewing documents for corporate and business matters – and do so with the best interests of your business in mind. We also have extensive experience in advising on corporate and business strategies for those looking to sell or dispose of their stake in a business. As a boutique law firm, we offer the advantage of partner-level involvement at every step in the share transfer process. This small firm attention to detail is coupled with big firm resources that rival those with much larger offices in the legal industry. Making your business succession plan? Contact South Florida Law today on (954) 900-8885 or via our contact form.