Mar. 23rd, 2015

Spotlight: Part 2-Transferring the Business: Closely-Held or Family-Owned

Jerry Nichols, CPA

Is the business for sale? Who are your potential buyers?

As you have continued to develop the business, you reach a point of asking yourself if you are ready to sell. In the last article, I discussed the timing or lack of timing on transferring the business.

Having decided to actively work on the plan to market the business, you need to find a buyer. Who will the buyer be? What alternatives do you have? With the alternatives, there may be a conflict between what is best for you and your family and the on-going business.

With the small business, one of the potential buyers is the current management team. You would evaluate the talent of your team and approach them to acquire the business. They would be most familiar with the business operations. You will decide if they have the ability to continue the business and to work together as a team.

There can be a tax advantage for a small business owner to create an employee stock ownership plan. This is referred to as an ESOP. In basic concept, a plan is developed so that all qualified employees benefit from the future success of the business as part of their retirement planning. This type of entity does require a certain size due to the complex regulations required and financing. The lending requirements, repayment terms and covenants can be complex. It also requires management expertise, an informed work force and culture believing in the long-term sustainability of the business. You benefit due to a deferral of taxes on your sale proceeds. This can be an attractive element of the ESOP purchase.

Finding an outside party creates additional complexity and uncertainty. At the initial stage, this search will be kept extremely confidential. A limited number of company personnel may be needed to disclose this plan. A hint of a potential sale of the business will have an impact on employees, customers and vendors. Such disclose may result in a diminished value of the business due to employees leaving, customers finding alternatives and vendors changing terms of sale. This may lead to the use of a qualified business broker or investment banker to assist in this search.

You may have in mind a potential buyer for the business.

  • There may be a customer that would like to incorporate your business into their operation to enhance their process or product.
  • A vendor may be seeking a way to enter an end market to vertically integrate.
  • Your local competitors may wish to consolidate, increase market share and improve efficiency of operations. These buyers tend to look at a return on their purchase based upon improving your operations or theirs.
  • Finding the strategic buyer is a more difficult task for the small business owner. This buyer is looking to purchase your intangible assets to leverage their strengths. They are willing to purchase above a normal value based upon a rate of return. This will require the use of business brokers and investment bankers. The buyer may not be in the current geographic market. They may not currently have a similar product offering. They are looking to make an impact in their own business operation. They are looking for people, product or process, plant capacity or a pipeline to the market. They wish to take your intangible assets and significantly increase the return on those assets.

For the family-held business, the plan is altered as it will take on a generational perspective. You are not only evaluating your exit strategy, but also evaluating the impact on the family. A sale of the business to outside parties will close the door for family members to be able to control their future. This may create conflict among family members beyond the financial implications. Some may be glad to cash in and others may wish to take over.

To transfer to the next generation requires a long-term process of preparing that next generation. You will have led in this process. It should not be left to chance. You will evaluate both the business and family implication of making this transfer. You will need to address those involved in the business and those not involved in the business. You will need to arrive at your own sense of equity between these different parts of the family.

For the future leaders of the business, you may wish to use your outside advisors to assist in this evaluation process. For those taking over the business over time, are they ready? You will have provided either formal or technical education. They will have developed a leadership style that is their own and is accepted by company personnel. They will understand the company product or process. They will understand the strength of the company and the future direction needed to keep the company moving forward. They will have experienced adversity and learned to overcome and improve. They will have a respect for what has been accomplished and a desire to improve and continue. You will be willing to let them make decisions, fail and make changes.

Next: Transferring the Closely-Held or Family Owned Business – Part 3: We will discuss pricing for a transfer to a strategic buyer, to family members and to other third parties. Is price the only concern in a transfer? Are there tax strategies that can help to maximize the pay-out?  

Jerry Nichols, CPA is a Shareholder of Hungerford Nichols CPAs + Advisors. Jerry has been with the firm since 1972 and has developed deep, long-term relationships with clients and has become an essential advisor to them over his many years of service. He provides key ideas and assists with implementing strategies to improve business operations and minimize current and future tax dollars.

Hungerford Nichols is a Tax, Auditing and Business Advisory firm with offices in Grand Rapids and Greenville, MI. The firm is celebrating 74 years of helping closely-held and family-owned businesses in West Michigan.