Whether it’s your children, grandchildren, nieces or nephews, passing your business to a younger generation can help ensure your legacy lives on. For an intergenerational transfer to be successful, it requires forethought, planning, mentoring and direct conversations with your family members. It’s imperative that you and your successors are prepared for the transition.
When a family transfer may make sense
A family transfer could make sense if a business has the following attributes:
- One or more designated junior family members who have a holistic understanding of the business and have expressed a desire to own and lead the company.
- If ownership will pass to multiple family members, you should be confident in their willingness and ability to work together.
- Key personnel, suppliers and customers should be familiar and comfortable with this next generation.
- Considerations should be made for how a sale may be financed or which wealth transfer techniques may be used. In doing this, special attention should be paid to the seller’s financial needs from the sale, tax implications of the transfer and the potential for increased financial risk to the company through financing the transaction.
When you’re ready to sell your business, if one or more people own the company with you, a partner can be a logical successor. However, you may have an agreement that provides conditions on the transfer of the company. For example, if a buy/sell agreement exists, you may be required to sell (or at least offer to sell) your stake to the remaining partners when you decide to step away. Regardless, a business partner knows the business and is often ready to increase their share in the company.
When a sale to a partner may make sense
A sale to a partner may make sense if, at the time of the transfer, a business has the following attributes:
- There are one or more partners who are ready, able and willing to buy your share of the company.
- There have been conversations about each party’s intent to sell/buy, and a funding mechanism is in place. It may be advisable to have a right of first refusal agreement established.
- The purchasing partner should have a good grasp of the entire business or a strong management team in place to fill any skills gaps when the selling partner exits.
Identifying a viable candidate for transferring the business is likely one of the biggest issues you'll face. One common approach is selling to employees. This arrangement could be mutually beneficial because of continuity and familiarity. The two most common ways to transfer ownership to employees are through a management buy out (MBO) or employee stock ownership plan (ESOP). If properly structured, an ESOP may enable an owner to defer or even eliminate capital gains on the sale of the business.
When a sale to employees may make sense
A sale to employees may make sense under the following conditions:
- The company has long-tenured employees with a demonstrated track record of running the core business operations, or you (the owner) plan to remain with the company to manage and lead it after the transfer of ownership.
- Employees should have a desire to be owners and commit to the business long-term.
- The company may need low levels of debt to facilitate the transaction and have sufficient cash flow to service any new debt.
One strategy for selling your business is a third-party sale. This transaction is defined as selling the company to a non-affiliated third party. Third-party buyers typically fall into two categories:
Strategic buyer — A competitor, customer or supplier
Financial buyer — Someone with the financial means to hold the business as an investor, such as a family office, a private equity group or high-net-worth individuals
When a third-party sale may make sense
For a third-party sale to make sense, businesses should have reached certain thresholds to make themselves attractive to potential buyers. These include milestones for size, growth prospects, competitive advantage and transferability. These are targets and not absolute benchmarks. Hitting them will make your company more attractive to a broader pool of buyers and potentially increase the sales price. Following are examples of performance markers:
- Many mergers and acquisition (M&A) advisors, corporate buyers and private equity groups tend to target companies in the lower-middle market and up, which starts at $5 million in earnings before interest, taxes, depreciation and amortization (EBITDA). That said, there is no minimum revenue threshold when selling your company to a third party.
- Businesses operating in higher-growth sectors or businesses with growth rates substantially higher than industry peers tend to attract more buyers and higher sales multiples (which drives higher valuations).
- Recurring revenue streams or a defensible market niche through things like subscriptions and long-term contracts, proprietary processes, patents and exclusivity deals tend to be more attractive to third-party buyers because the earnings of the company tend to be more consistent with these factors present.
- Documented systems and processes, solid relationships with a diverse customer base, a strong company culture and a demonstrated depth in the management team help a buyer know the value of the business can be transferred and is not dependent upon the current owner.
- Several years of audited financials, a clean balance sheet and low levels of debt are often requirements for a third-party sale.
If you’re in a situation that warrants exiting your business, liquidation could be an appropriate option. Liquidation involves selling the assets of the business, closing all accounts payable, paying off all debt and keeping whatever remains. Liquidation is generally an option of last resort. If you have at least three to five years before you plan to exit the business, you may be able to increase the likelihood you could transfer the business through a different exit channel.
When an orderly liquidation may make sense
You may consider liquidating the company if it meets one of the following criteria:
- Assets are worth more than you would receive from the sale of the business. Since the valuation of the company is dependent on the income it can produce, owners of businesses with high asset value and low income may net more proceeds through liquidation versus pursuing a sale of the business.
- The business value is dependent on the owner’s continued involvement in the operations. If the income-producing potential is tied to the owner’s involvement, a buyer will generally be unwilling to offer more than the asset value.
- You or the ownership group needs to raise cash quickly. Understanding they will likely leave value on the table as compared to other exit options, liquidation can be a reasonable option.
