September 15, 2014

Effective Business Succession Planning: Part III


By Brad Eriksen

From the Jordan Ramis Archives

Previous articles in this series on succession planning addressed the need for a buy-sell agreement among the owners, and noted several tax-advantaged methods for transferring a business. This final installment addresses the more standard techniques for transferring a business.

Selling the Business

Selling the business is not often considered a succession-planning strategy, since a sale often happens as a last resort when no planning has been done. However, selling the business, whether to management-level employees or an outside party, is an effective succession-planning tool. Prior planning is necessary, however, to obtain maximum value. Financial statements must be spruced up, operational issues addressed, and the business marketed to the broadest audience possible.

Stock Sale vs. Asset Sale

The seller generally prefers a stock sale, where the owner sells his shares of stock directly to the buyer. This allows the seller to recognize capital gains (rather than ordinary income) on the sale. All of the assets and liabilities of the business are also transferred to the buyer.

The buyer generally prefers an asset sale, where the purchaser buys specific assets directly from the business. This allows the buyer to pick and choose which assets to purchase and which liabilities to assume. An asset sale may result in the recognition of some ordinary income, as well as capital gains, to the seller, depending upon the business' tax basis in the assets and the allocation of the purchase price among the assets.

Bootstrap Acquisition

In a bootstrap acquisition, a small portion of company stock is sold to management employees or to an outside party. The corporation then redeems the owner's remaining shares of stock. The purchase price is typically paid over a period of years, since neither the corporation nor the new owners have sufficient resources to pay the purchase price in full. Accordingly, a bootstrap acquisition places some risk on the selling shareholder, since payment of the purchase price depends upon the future success of the business.

Merger or Consolidation

In a merger, the business generally merges into a larger company. The owner of the acquired business receives shares of stock of the acquiring company in exchange for shares of stock of the company being acquired. If the acquiring company is publicly held, the seller gains a certain amount of liquidity in the new stock. The seller may also receive an employment agreement or consulting agreement with the acquiring company to assist with the transition. The acquiring company generally has the depth of management necessary to assure the continued success of the business. If structured properly, a merger may be a tax-free transaction for the seller. However, when the shares of the acquiring company stock are subsequently sold, gain must be recognized and capital gains taxes paid.

Combinations or variations of these tools, can be used to craft a succession plan for any business situation. Careful thought and analysis are necessary to meet the needs of the business owners. To ensure a smooth transition and to obtain top dollar for the business, the planning process should begin years before the owner anticipates leaving the business.

Click here for Part I | Click here for Part II

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