When family members don’t take over your business, consider selling it to one or two key employees.

Originally published in Industrial Distribution, August 2007
By Gary Pittsford, CFP®
President and CEO, Castle Wealth Advisors, LLC

It can be rewarding to watch a son or daughter take over your business when you retire, but that’s not possible if they choose another career. If you are in this situtation and have one or two senior managers with a successful track record working for your company, creating a succession plan around those employees could be a good idea. I’ve helped design succession plans for business owners who identified key employees with the talent to manage and grow the company long after the current owner retires.

Identifying that key employee is only the first hurdle in the succession process. Financing a buyout is the next step. Finding a bank to make loans to key employees to buy a company is hard to do in these tough times. Sometimes a key employee might be able to put down 10% to 15%, and sometimes less. The owner can consider selling stock to one or more key employees over time by using a promissory note.

For example, many owners tell me that they would like to give to the key employees 10% or 20% of the stock because they have been working for the company for many years. Let’s assume that the owner gifts 20% in one year or over a series of years. Once that step is finished then the owner could move to step two, which might be selling 29% of the stock over a period of years to the key employee. That would bring the key employee up to 49% ownership and the owner would still have 51% and still retain control of the company. If the owner takes five years to make this transition they are still collecting all of their benefits and salary during that time period.

If the key employee is doing well and running the company successfully, then the owner may then feel comfortable entering into a transaction to sell the remainder 51% of the stock. The owner could take back an installment note for the value of 51% or perhaps a bank might be willing to make a loan for part of the purchase price to the key employees. Now that they have 49%, they have equity in the company that they can pledge as collateral in order to borrow part of the purchase price. For example, perhaps the bank would loan 30% and that would give the owner a large check which would be liquid assets they could invest for retirement. The remaining 21% could be paid off by using an installment note over time.

There are a dozen different ways that key employees can buy out an owner, this scenario is only one of those options. In 2011 and probably 2012 many banks are going to be reluctant to make large loans to closely held family businesses. However, if the key employee has a proven track record, has successfully managed the company over the last three or four years and has acquired stock in the company that can be pledged as collateral, a combination of a SBA loan and bank loan could possibly be acquired to complete the purchase.

This sales process could take three to five years, or it could take 8 to 10 years to complete, depending on the design of the succession plan. The owner needs to negotiate agreements with the new buyers pertaining to salary, employee benefits, and health insurance. Also, selling goodwill, using deferred compensation, non-compete agreements and other types of contracts should be considered and possibly used in the buyout/succession plan.

If the owner personally owns the real estate then they can retain the real estate and sell the business. By retaining the real estate they would also continue to receive the monthly rent for many years into the future. The building and the rental income could be part of their overall retirement package and one of the assets that could be passed on to the next generation within the family.

After 35 years of helping family businesses design and implement their succession plans I would estimate that about 20% of the owners actually sell to key employees. About 40% sell to children and approximately 15% sell to another coop member in their industry.

Gary Pittsford, CFP®, is President and CEO of Castle Wealth Advisors, LLC. Castle specializes in helping families and closely held business owners with valuations, succession planning, estate and income tax analysis and retirement income security. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or e-mail Gary directly at .