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September 17, 2013

An Employee Buy Out May Not be Out of the Question with the Right Exit Plan

Many, probably most, business owners would like to sell their businesses to their employees, but for one nagging problem: The employees have no money. And owners simply cannot risk selling a business to employees who have no cash.

Exit Planning

If you would like your employees to one day own your business, ask yourself this question: “When do I want to leave the business?” If the answer is NOW, you are probably out of luck. However, if the answer is “five to eight years,” a well-designed Exit Plan can make that happen—if you start today.

Any buy-out plan must accomplish three goals:

  1. Minimize owner’s, company’s and employees’ risk, by keeping the owner in control of the business and sale process until the owner receives entire purchase price.
  2. Ensure owner receives full value for ownership interest.
  3. Minimize income taxes of both owner and employees.

Unless a buy-out plan meets these goals, owners are wise to reconsider selling to employees. If, on the other hand, owners plan and begin to execute a transfer plan well in advance of leaving, achieving these goals is possible. Special planning is required to meet the income tax minimization goal.

A plan to execute an employee buyout has two stages:

1. Each year employees buy small amounts of stock until they have purchased and paid for approximately 35% to 40% of the ownership (usually non-voting). Ordinarily, this stage takes five to eight years. At the end of this stage, key employees are in a position to approach a bank.

2. Assuming the business continues to be profitable, paid-up owners of 40% of a company are usually able to secure bank financing to purchase the remaining balance of the owner’s stock.

This buy-out plan keeps an owner in full control until all monies are received, significantly reducing the risk of not receiving full value. Under this scenario, an owner can successfully cash out of the business because exit planning is initiated well in advance of leaving.  This allows the owner to choose a successor, exit on the desired timetable, and leave with the desired cash.

This Two-Stage Plan is a very brief summary of a relatively involved buy-out plan. Of course, there are many additional design issues specific to individual businesses. . If you would like to talk about Exit Planning for your business, please contact your Anders advisor.

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