COVENANT BUSINESS PLANNING SOLUTIONS

Transferring Your Business to Your Key Employees Part V

In the previous blogs of this series on Exit Options involving key employees, we discussed the details of each of the four options available to business owners. That included the Long Term Installment Sale, the Leveraged Management Buyout, the Employee Stock Option Plan (or ESOP) and the Modified Buyout. We thought it would be helpful to demonstrate the advantages and disadvantages of each, with this simple chart.

 

SUMMARY OF SALE TO KEY EMPLOYEES

The advantages and disadvantages of each exit method are:

 

Installment Sale

Advantages

  1. Rewards and motivates employee/buyer because the business can be acquired with little or no money and can be paid for using future cash flow of the business.
  2. Key employees receive the entire business.

Disadvantages

  1. Owner receives little or no money at time of closing.
  2. Owner is at significant risk of receiving less than the entire purchase price.

 

Employee Stock Ownership Plan (combined with Key Employee Buy-In)

Advantages

  1. Rewards and motivates employee/buyer because part of the business can be acquired at a reduced price.
  2. Key employee receives operating control of the business.
  3. Owner receives cash at closing (which can be immediate).
  4. Company may gain additional financial resources from equity investors.
  5. Significant tax advantages associated with ESOP purchase.

Disadvantages

  1. Key employees may want all or most of the company.
  2. Initial funding of plan usually needs to be made with company money otherwise payable to owner.
  3. Business must continue to pay off bank loan after owner leaves. Because key employees will be responsible for running the company they will likely prefer such debt to benefit them directly.
  4. Cost of maintaining ESOP.

 

Management Leveraged Buyout:

Advantages

  1. Rewards and motivates employee/buyer because part of the business can be acquired at a reduced price.
  2. Key employee receives operating control of the business.
  3. Owner receives cash at closing (which can be immediate).
  4. Company may gain additional financial resources from equity investors.

Disadvantages

  1. Requires the use of debt and private equity investment which many businesses may not be able to attract.
  2. Key employees may want all (or most) of the company, and not be satisfied with a minority sale.
  3. Burdens the company with significant debt.

 

Modified Buyout:

Advantages

  1. Rewards and motivates employee/buyer because part of the business can be acquired at a reduced price.
  2. Key employee receives entire business.
  3. Owner receives at least 75 percent of fair market value of the business (and usually more).
  4. Owner can stay in control of business until full purchase price is received.
  5. Flexibility after initial key employee buy in (of 30-40 percent ownership) is completed.
  6. Majority owner can sell balance to key employees for cash, sell all of company, sell shares to third party, or sell the owner’s interest to ESOP.

Disadvantages

  1. Owner does not receive entire purchase price for several years.
  2. Owner generally remains active in business until initial employee buy in is completed.

 

Which is best for you? When you work with Covenant Consulting Group, we not only show you the advantages and disadvantages of each of these methods, we provide you with real world expectations, and work with your Exit Team. Schedule your FREE consultation with Covenant Consulting today!