This session will address an often-selected exit path for the majority of privately held businesses that, because of their size and sophistication or because of the owner’s personal preferences, are not good candidates for an outside third-party buyer, such as a private equity firm or strategic buyer. This path is often called the “Insider Transfer” where the buyer is your key employees. If planned and executed successfully, this path can provide you with minimal risk, maximize return, and complete control over the process. As stated previously, most businesses transfers are accomplished through an internal transfer to key employees. The reasons for this are:

Achieves the Personal Goals of Owner
As you start the exit planning process by articulating your personal and financial goals, you may have expressed a desire to keep the business in the community, maintain its culture, and continue your legacy. Many owners wish to preserve the family type atmosphere and culture they have built and realize that a sale to an outside third party would mean the end of that culture. With an internal transfer, the business culture can continue.

Other Paths Are Not Good Fits
Your business does not have enough current or future value to attract outside third party buyers. For example, a private equity group will require at least an EBITDA of $2M on the low end, as would an outside third-party buyer. Your business may never reach those numbers. Also, for an ESOP (Employee Stock Ownership Plan) to work there needs to be a sufficient amount of payroll to support the plan in addition to the ongoing compliance costs.
Additionally, there are certain businesses that are not good candidates for a third-party sale. For example, due to their very risky nature, construction companies are hard to sell. They lack recurring revenue streams, are project based, and oftentimes rely on the owner to generate new work.

Enough Outside Wealth & Wish to Continue to Work
Internal transfers provide very little upfront cash at closing as your key employee buying group does not have the money nor can they raise capital or obtain financing to pay you at closing. Instead, they must rely on the business to continue to produce cash flow and profits into the future so that you can be paid. There is risk here. However, that risk is not of consequence if you have accumulated enough wealth outside of the business to retire in comfort. And if you desire to continue to work, an insider transfer plan may be a good option for you.

For an internal transfer to be successful, there are 9 elements that must be present. They are:

Element 1: Time
In order for an insider transfer to be effective, unless the insider buyers have their own source of cash, you will have to be willing to take time (typically 5 to 10 years) to execute and complete the transfer along with your insider buyers. Typically, the more time owners take to transfer the company, the less transaction risk they incur and the more money they receive.

Element 2: Sufficient Cash Flow
While healthy cash flow is critical to the success of any type of exit, no insider buyer wants to buy a company with anemic cash flow. In a transfer to insiders, however, cash flow assumes critical importance because initially (but only temporarily and if designed correctly) it is a major source of funding for the owners exit. Your key group (KEG) most likely will need their share of the company’s cash flow to execute the inside transfer plan.

Element 3: Capable Management Desiring Ownership
Having a motivated management team in place and capable of replacing you is hugely valuable. In a transfer to insiders, capable management must also desire ownership and be willing to sign personally for any acquisition financing or ongoing company debt.

Element 4: Focus on Taxes
In an insider transfer, it is imperative that you structure the sale to minimize taxes on the company’s pretax cash flow because without planning, that cash flow can be taxed twice.

Element 5: Incremental Transfer of Ownership
One of the most important advantages of a well designed insider transfer plan is that it gives you, the owner, the ability to regulate how ownership is transferred, the timing of the transfer, and how much ownership is transferred. If the company performance falters, employees stumble or if you decide to sell to an outside third party, a well designed internal transfer plan keeps the owner in control.

Element 6: Minimal Owner Risk
While you take risks every day, I am sure that you don’t relish risking yours and your family’s future financial security. Therefore, I use strategies to hold voting and operating control in your hands and shift operational business risk from your shoulders to that of the incoming owners so that you stay in control of your company until you receive the entire amount needed to secure your financial security, and not a moment sooner.

Element 7: Written Plan
A transfer plan should be contained in a written document and be communicated clearly to the eventual owners. If the plan is not in writing, it simply is not credible and neither you or your successors will take it seriously. More importantly, the written plan in the playbook that you’ll use to coordinate your actions, those of the new owners and those of all advisors. All plans should include a timeline and provide accountability – who will do what, when – for all participants.

Element 8: Owner Education
You need to understand the ins and outs of the insider transfer because, unlike a sale to a third party, you control the business and the exit process until you receive all of your money. Your exit planner should be providing you with this education.

Element 9: Experienced Advisors
As is true with all exit paths, a transfer to insiders requires the input of a variety of professional advisors. Your exit planner is the quarterback of a team of advisors who have experience in this area. The more varied the experience, the better able they are to foresee and meet contingencies and unexpected events.

Learning Objectives:

• When does an insider transfer make sense for a business owner?
• What are the main elements necessary to successfully stage an internal transfer?
• Value Acceleration is foundational for this exit option.
• The Two-Step Insider Plan and plan considerations.
• How can we make Uncle Sam our partner?