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Between the credit crisis, inflation roaring back and a change in the business cycle private business owners have been finding it more difficult to sell their business to outsiders.  More and more we’re also finding the children of private business owners aren’t interested in taking over the business or their parents aren’t interested in having their children take over the business.

This leaves the owner with three exit strategies.  They can continue operating the business, they can liquidate their business or they can sell the business to their managers.  If your business is either a hard to sell business or one that is getting slammed by the current economic environment, selling to your managers might be your best option.

Preparing your mangers

The number one mistake we see business owners make is not having a conversation at least two years in advance with their managers about the possibility of purchasing their business if and when the time comes.  Managers are never prepared to take over a business.  They often have misconceptions about what it takes to run a business and because the owner wants to sell the business quickly, the misconceptions often cause major problems in putting together a transaction.

We suggest that you have a conversation with your managers if you want to consider having them purchase the business.  You also want them to learn about the world of debt and what they will have to do to finance the business, even if you as the selling owner will be their bank.

We’ve seen too many managers balk at the prospect of personally guaranteeing debt owed to the selling owner.  Remember, if you sell your business to your managers, there is a very good chance that you will be the bank for at least the first three to five years.   Your managers need to understand that it’s rational for you to expect the same sort of security arrangements as any lender your managers would borrow money from.

Your manager’s advisors

The second error we often see is managers choose lawyers, business advisors and CPA’s who don’t understand internal transfers.   The goal for you and your managers is to transfer the business at the lowest tax cost for the managers and the highest after tax return for you, the selling owner.  This often requires that creative thinking be employed.  If your manager’s advisors don’t understand how internal sales are made tax effective, you will get less than you deserve.

We think it’s a good idea to help your mangers choose their advisors at least one year in advance of your transaction.  Since your managers will not have any money, it might even been a good idea for you to front money for them to interview and choose advisors that will help your future deal go through in an effective and efficient manner.

Helping your managers choose appropriate advisors is something you can do ethically as long as you’re not in the throes of putting together a deal.  If your managers are just shopping you can meet with these advisors and help your mangers understand whether they will help the deal move forward or not.  Giving your managers a year to get comfortable with their team will help them understand that you aren’t trying to force your managers to use an advisor who is friendly to you.

Understand how a transaction could be done well in advance

The third mistake we see if owners don’t understand the transaction that is being proposed.  You are an expert at running your business.  Doing an effective internal sale will require you to learn new terms and financing techniques that you likely have not used in your business.

If you take time two years in advance of your proposed transaction learning about your options, you will make a more informed decision about what’s best for you, your managers, your employees and the other stakeholders that are important to your business.  If you’re trying to learn while putting together a deal, you will not learn the many options and variations of those options that can provide true value for everyone involved.

What sort of things have you done to think about or plan for an internal transfer?  Click on this link, I would be glad to set a time to talk.

Josh Patrick

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Securities and Investment Advisory Services offered through NFP Securities, Inc. (NFPSI), Member FINRA/SIPC. Stage 2 Planning Partners and NFPSI are not affiliated.

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Topics: exit strategies, for business owners, business exit planning

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