Transferring Business Ownership
Four common scenarios that will get you thinking.
One of the most difficult decisions every business owner eventually must make is how and when to transfer business ownership. Perhaps because we all strive for some sense of immortality, we tend to procrastinate over these types of decisions for as long as possible.
If we choose to prolong these decisions too long, however, the transfer of business ownership, if not properly planned, will become problematic at best, and a complete disaster at worst. My goal here, then, is to provide some general options and stimulate some thought as to how and when you might decide to transfer your business interests.
Once you get serious about making some decisions about your long-term business plans, you need to retain immediate help from an expert-an attorney, accountant, financial advisor, or other. They will provide you with the support you will need to ensure your plan is properly executed.
Within the US legal system, there are countless ways to transfer the ownership of your business. For our purposes, I’ll provide basic information on just four of the more popular vehicles used: family limited partnerships, employee stock option plans, buy-sell agreements, and selling to an outside buyer.
Family limited partnerships
Family limited partnerships are most often set up with one or two general partners and the rest of the partners having status as limited, non-voting partners. The general partners are likely to be one or two or more business partners, or perhaps a business owner and his or her spouse; they control the partnership. The limited partners may be involved in the business, but they typically do not control or manage the business.
The partnership then has the ability to pass on partnership interest to the family members as limited partners through the use of gift tax and estate-tax exemptions. In recent years, these exemptions have been increased substantially. Regulations currently allow $2 million in estate-tax exemptions and $1 million in gift-tax exemptions. If you should choose to transfer your business interests to family members, this provides some flexibility in terms of how the business can be transferred and the timing by which this can happen, while still allowing you to maintain control over the business.
Employee stock option plan
If a business owner wishes to transfer some or all of the company stock to the employees of the company and receive compensation in return, an employee stock option plan, or ESOP, is an excellent way to accomplish this.
Implementation of this type of plan can be somewhat complex, but effective. In essence, an ESOP is a form of pension plan that allows the employees to invest in their own company and purchase stock as they invest in their pension fund. As your employees participate in the ESOP, they are, in fact, investing in the equity of your company. And as they become vested shareholders, their interest in the success of the company will increase significantly.
An ESOP does offer some unique tax properties that can be quite advantageous for you as the owner. If you have some interest in this type of business transfer, your hired expert can help you understand the details of how it will affect you and your business, and also spell out the relevant tax implications.
A buy-sell agreement represents a predetermined contract for the disposition of the business assets triggered by an event. This can be retirement, death, disability, etc.
Often, a buy-sell agreement is in place for the benefit of multiple business partners. The agreement will typically have a pre-established value placed on the business based on whatever formulation may make sense for all interested parties.
For example, let’s assume a business has two partners with equal equity and the business is valued at $1 million based on a sales and profits formula. One of the partners dies and the buy-sell agreement takes effect. It could specify that the surviving partner may buy the business interest out for $500,000. One of the ways to make this possible: Arrange for the business to buy a life-insurance policy on the partners. Hence, in the event of the death of one partner, the insurance proceeds can then be used by the surviving partners to purchase the remaining interest in the business.
Buy-sell agreements can also contain provisions as to who will manage the business operations, who is responsible for obligations in the event of liquidation, and other key business factors. The advantage of this type of agreement is the flexibility it allows in outlining exactly what will happen in the case of specific events.
Selling to an outside buyer
When selling your company to an outside buyer, you have two basic options, an asset sale or a stock sale.
An asset sale is exactly what is says: Individual assets of the business are specified in the purchase agreement, assigned a value, and sold as such. There may or may not be an obligation for finance agreements attached to assets. The asset sale agreement, however, should warranty title of assets free and clear of liens; it may also include intangible assets such as patents, customer lists, and other intellectual property. The liabilities are typically not part of an asset purchase, but may be paid off by some assets-such as cash and accounts receivable-prior to the transfer of those assets.
When a stock sale occurs, the purchaser acquires all assets and liabilities of the company. The advantage to the buyer here is that a stock purchase allows the buyer to continue to do business in the same manner as before the purchase. The business name, customers, tax ID numbers, vendor agreements, etc., all remain in place; the only difference is someone else owns the business. The disadvantage to the buyer is that the buyer assumes all liabilities of the company, disclosed and undisclosed. A lot of due diligence is necessary by both parties to avoid future legal entanglements. As with every other scenario discussed here, professional help here is an absolute.
Begin planning now
Although these are just a few of the more common scenarios, they should get you thinking about the future of your business. Certainly there are other means of transferring a business available to you. But regardless of whether you plan on transferring your business within a year or not for several years, consult a professional and begin making a plan now. Don’t leave this to chance. Having a solid plan in place is your best bet to ensure the future of your business goes according to your desires.
Marty McGhie (email@example.com) is VP finance/operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.