Three Ways to Sell Your Business to Employees, Children, or Other Insiders

Three Ways To Sell Your Business To Employees, Children, Or Other Insiders

Written by Lisa Cribben

October 7, 2024

When it comes to selling your business, there are several routes you can take, including selling to a third party, gifting or selling to your children, or selling to a group of insiders such as co-owners and employees. Insiders, who are already familiar with the business, understand its culture, and share its long-term vision, often make ideal buyers.

If selling to insiders seems like the best course for your business, the next step is deciding how to structure the sale. Here are three methods to consider, each designed to address the typical cash flow limitations of insiders. The best approach will depend on various factors, including tax consequences, risk, financing requirements, and your retirement timeline.

1. Sell, Bonus, or Gift Stock Over Time

One way to transition ownership gradually is by selling, bonusing, or gifting shares of stock annually. This method typically involves transferring small interests in the company while the current owner retains control during the initial phase. The owner maintains a majority interest (greater than 50%) of the voting shares during this period.

Once the owner is ready to relinquish control, the remaining shareholders and the company can buy out the majority interest. While this process may take longer and require more financial planning, it can be an effective way to transition ownership to company insiders.

2. Sell 100% of the Business in an Installment Sale

An installment sale, as defined by the IRS, involves receiving at least one payment after the tax year in which the sale occurs. For instance, a seller might receive 10% of the purchase price per year over ten years, transferring a proportional number of shares to the buyer with each payment.

Pros of an Installment Sale
  • Tax Benefits: The tax liability is spread over the installment period, rather than being recognized all at once.
  • Interest Income: The seller receives additional proceeds in the form of interest income on the balance owed.
  • Reduced Bank Debt Risk: Less bank debt is required, reducing the risk of default.
  • Higher Purchase Price: Buyers might be willing to pay more to incentivize the seller to accept installment payments.
  • Performance-Based Consideration: If tied to business performance, the seller may benefit from earnings growth during the installment period, which would be discounted in a lump sum payment.
Cons of an Installment Sale
  • Seller’s Risk: The seller bears the risk if business performance declines.
  • Delayed Full Value: The seller might have to wait until the debt is paid off, which could take five to ten years.
  • Tax Rate Uncertainty: Future tax rate changes could result in a higher tax liability.
3. Stock Redemption

In a stock redemption, the company buys out one or more shareholders, thereby increasing the ownership percentage of the remaining shareholders. For example, if you own 80% of the company and have two children who each own 10%, the company could buy your 80% interest, making your children 50/50 owners.

Pros of Stock Redemption
  • Capital Gains Treatment: Proceeds are treated as capital gains, which are taxed at a lower rate than ordinary income.
  • Interest Deduction: Interest payments are reported as a deductible expense on the company’s corporate return.
  • Easier Financing: The company can use its assets as collateral, making it easier to secure debt financing.
Cons of Stock Redemption
  • Multiple Shareholders Needed: This method requires multiple shareholders; it doesn’t work if there is only one shareholder.
  • Detailed Tax Requirements: Certain tax requirements must be met, such as the seller having no interest other than as a creditor in some cases.
  • Possible Installment Structure: Depending on financing terms, proceeds to the seller may still be structured as an installment sale.
Additional Options: Earn-Out Agreements

An earn-out can manage risk for both buyers and sellers by tying part of the purchase price to the future performance of the business. For example, the purchase agreement could stipulate that if revenue grows by $1 million by a certain date, the sale price increases by $100,000. If the target is not met, the additional proceeds are not paid, effectively decreasing the purchase price. Earn-outs can be used in conjunction with the methods mentioned above to limit buyer risk while offering the seller potential for a higher price over time.

Consult with Professionals to Start the Process

If you are planning a transition and considering your options, the first step is to consult with professionals experienced in such transactions. They can help you understand your financial goals and objectives to find the best plan to meet your needs. Hawkins Ash CPAs has a team ready to help you. Reach out today!

The experienced transaction specialists at Hawkins can assist you in determining which option is best for you and your business.

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Lisa Cribben
I lead our Firm's valuation services group and have been working with companies for over 25 years on their valuation and business sale and purchase transaction needs. I have experience working with clients in all industries including healthcare, manufacturing, agriculture, retail, and construction.

I'm able to provide expert advice with a deep understanding of my clients' needs. Over the years, I have gained extensive experience in testifying in court on valuation and other financial matters. Additionally, I'm a frequent speaker on topics such as valuation, sale transactions, and transition planning.

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