A Better Way to Sell Your Business: Part 2 - Structuring the Transaction

A Better Way to Sell Your Business: Part 2 - Structuring the Transaction

In Part 1 of this two part article, “A Better Way to Sell Your Business,”we looked at a transaction in which a seller of a going business was retiring, and a young relative or key employee, who lacked sufficient initial funding for a down payment, was a proposed buyer.

In Part 1, we looked at the transaction from the perspective of a buyer who lacked sufficient funds even for a down payment. Here, we will further consider the transaction, but from the perspective of the seller who is looking to retire from the business, yet wishes to maximize the sales price and is willing to accept a down payment secured from a third party other than the buyer and a secured payout over time.

What happens next

The seller may give the buyer, his new “partner,” a contract that calls first for a trial or transitional period to develop the new relationship. That way, if the arrangement does not work out, the contract allows the owner to rescind the agreement. If it does work out, the arrangement then can provide for the company to issue equity participation, i.e., a partnership interest or shares via direct sale or an option agreement, vesting and exercisable over a period of time. Thus, the equity ownership of the business can be structured to pass either immediately on the closing, if the seller feels secure about receiving the full payment for the business, or the equity could remain subject to being collateral for the payment of the full purchase price.

Alternatively, if the seller was not sure about the buyer’s ability to fulfill the payment obligations over time, the closing could provide for transfer of only partial equity, subject to forfeiture on non-payment of any portion of the purchase price. Another variation would have the equity in the business be made subject to an earn-in by performance of the business over time. The measurements for the earn-in could be set by establishing performance milestones such as maintaining 85% of revenues or profits, growing the business annually or simply by the buyer successfully making annual payments.

Structuring the transaction

The seller may also structure the transaction so as to realize tax and other benefits through the use of a further alternative, options exercisable for equity on future payments, with the options to provide that they vest and are exercisable only if the prospective owners remain on the job and with the business performing in accordance with expectations. If the buyer left, or if the seller became unhappy with the arrangement, for good cause, the seller would have the right to buy back the options or stock already transferred to the buyer at a prearranged price. From the seller’s point of view, this arrangement is desirable. He can time the payments for himself to fit his needs – for both tax and spending considerations; and, he is protected against a buyer’s failure to perform in accordance with the agreement.

The payments can be structured to be a mix of ordinary income, short term and long term capital gains, thus having the tax advantages of a regular installment sale. There are even ways to structure such an agreement so that payments can go into a trust, a retirement plan or an estate – oriented vehicle. These tax-advantaged structures require the input of sophisticated professional advisers who can provide projected results from which the seller can select the path most suited to his post-sale plans and needs.

Conclusion

The format described has proven to be a way for owners to retire and realize the greatest value for their efforts.

Sometimes, the only way the owner of a business can retire without liquidating it is to find others to continue the business, and to arrange a secured time payout through outside financing sources, such as a bank or investment fund. The format described above has proven to be a way for owners to retire and realize the greatest value for their efforts.

Moreover, for the seller not yet ready to fully retire, he can realize the fruits of his labors even before retirement by selling the business to a person with whom he already has experience and familiarity, and use this type of sale transaction to immediately lessen his involvement in administrative matters. This would allow the seller, if he so desired, to return to a more active role in aspects of the business that he once enjoyed, such as sales development, research and development of new or improved products, or just plain socializing on the golf course with prospective customers.

To refer to Part 1 of our A Better Way to Sell Your Business piece, click here.