February 2018
By Gary Pittsford, CFP®

President and CEO, Castle Wealth Advisors, LLC

If selling your family-held business to key employees is your best option, then outlined below are some ideas to think about.

A short business valuation report is usually a good idea in order to have an outside, independent value established to give to your one or two key employees. Also, that valuation will help establish the usable cash flow that the company has to work with. That Usable Cash Flow is very important to make sure that there is enough cash to pay income taxes, pay off the seller, and have some extra cash left for the buyer.

Many business owners sell to one or two key employees because they are the best qualified buyers for a business in their market area. Some business owners have children who pick different careers and are not interested in the family business. Quite often, one or two managers in the company are young and eager and would like to take over a successful business and continue to make it grow.

Outlined below are some initial steps.

Step One – Education
One of the most important steps, 3 to 5 years before selling the company, is to make sure that these key employees are well trained in every aspect of running the business. Over the years we have learned that most key employees are good at two or three different aspects of running the business, but they have not been exposed to every element of that company. They may know how to order inventory or handle advertising. They may handle all of the employee duties and deal with customers.

Two to three years before selling the business it’s important that they learn all of the financial aspects of running the company. They should go with the owner when a meeting is established with the business attorneys, accountants, bankers, casualty insurance agents and other outside advisors that work with the business. It’s also important that all of these outside advisors understand that within 2 or 3 years the key employees are going to be buying out the owner.

During these beginning stages, make sure that the key employees can handle every aspect of running the company. If there is a problem, we need to work on it now.

Step Two – Valuation & Financial Review
About 1 or 2 years before selling the company you should work with a business appraisal firm that thoroughly knows your industry. Our firm, Castle Valuation Group, LLC, can help you with that. This short valuation report usually includes the review of the last 2 year’s business financial statements and tax returns.

This independent valuation helps the key employees understand that the pricing of the company is within a normal range. This valuation report also helps establish all of the “Usable Cash Flow” that the buyers and sellers have to work with.

Most business owners think about selling between 10% and 25% of the company stock to key employees over a 3 to 4 year period. Once that minority ownership has been transferred to the key employees, then the owner can think about selling the remaining stock, either by having the key employee get a SBA bank loan, or the owner may consider taking back a promissory note and the key employee can pay them over time. Most business owners prefer to get paid a lump sum of cash for the remaining stock and that’s why a bank loan is normally the preferred choice.

Step Three – Your Advisor Team
At least 2 to 3 years before starting this selling/transition process, it’s important to have some discussions with your primary business advisors. You should discuss with your business attorney, accountant, and financial advisor what your plans are and get their input pertaining to the transition process.

Your attorney will need to prepare any legal documents that may be necessary, such as stock redemption agreements, employment contracts and possible promissory notes. Your accountant will need to calculate the capital gains tax that will affect you from selling the company, and also advise you on taxes pertaining to your personal tax return.

Your financial advisor will be responsible for helping you prepare new asset allocation models pertaining to personal assets, cash that you receive from the sale of the business, and retirement accounts. The net worth that you have on the day that you sell the business is very important because that net worth will provide your retirement income security and future assets for your family.

We usually suggest that your financial advisor should be a Registered Investment Advisor that is licensed with the SEC. They should be an independent firm that is not affiliated with any large company and they should be fee-only. As you go into your retirement years, you want to reduce annual expenses and eliminate commissions as much as possible on your retirement investments. If you have questions, please contact us. Our firm Castle Investment Advisors, LLC can answer your questions and show you options to protect your net worth.

Step Four – Business Transition Plan
Making sure that your key employees are educated in every aspect of the business is very important. Usually, education comes first. Start working with your advisory team, at least 2 or 3 years before selling the company, and discuss every possible idea that may help you in this process. Developing a blueprint that encompasses every aspect, and developing a timeline, are important items for your advisory team to prepare for you.

As you start the process of selling stock to your key employees, it’s important that you notify CCA Global and let them know that within 2 to 3 years there will be a new owner for your corporate stock. They must approve all new owners that become part of the purchasing cooperative.

Step Five – Business Documents
During the 3 to 5 year process of selling a minority interest in the company to key employees, it’s important that the company have a well prepared stock redemption agreement that all stockholders should sign. This stock redemption agreement should cover all of the important “trigger points” that could affect every stockholder. Those trigger points include, death, divorce, disability, personal bankruptcy, termination and retirement.

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 .