After more than 15 years spent working with and advising entrepreneurs, I know that they are hard-working people, excellent with numbers, and who have cultivated a keen business sense in line with their values.
But what happens when, after having built a successful business for a long time, even after having devoted their whole life to it, the time comes for them to sell the fruit of their labor?
If you own a manufacturing company, it’s relatively simple: you may one day receive an offer from a third party or even from a competitor looking for growth.
But if you have founded a service company, another path may arise: internal succession. In this case, the passing of the torch must be prepared, both to ensure the success of the transition and to find the appropriate financing structure.
As a seller, you could then find yourself faced with a dilemma: accept a “big check” or pass on your “baby” to a buyer with limited means, but in whom you believe.
Benefits for both parties
Is it a good idea for the seller to finance the buyer? I leave it to you to decide when it comes to human relations issues, which must of course be taken into account.
From a strictly financial point of view, however, be aware that, if the advantages of this option seem to lie a priori on the side of the buyer — patient capital, maintenance of the commitment of the seller (which increases the probability of success of the ‘operation) — you can also benefit as a seller.
By making a loan to the buyer, and agreeing to receive a portion of the sale price over a longer period, you can often expect a better price, especially if you are selling intangible assets (the goodwill and intellectual properties of company, typically), which are difficult to finance by lending institutions.
In the case of a service company whose fair market value of shares is high, getting involved in the financing of the sale becomes, in my opinion, unavoidable. Having a bank finance such a transaction is very difficult and more often than not, your buyer will have an amount of equity that is inversely proportional to his motivation to take over.
As a seller, incidentally, if the shares of your small business are not considered eligible for the capital gains deduction (or if you don’t have the structure to multiply it), resorting to a sale balance may allow you to structure payments to spread the capital gain over a period of up to five years.
Not just a question of price
Establishing the right selling price for your business is a major challenge; determining the right financial package to use is just as important.
If you are financing only part of the transaction, it is in your best interest to familiarize yourself with the entire set-up of the sale, in order to make sure that the adventure is not too risky. Is there high leverage? Do you see expensive financing terms? Are there any clauses that could restrict the buyer’s ability to fulfill their commitments to you? All of this needs to be checked.
But what if your successor has limited financial means? You do not need to personally finance 100% of the transaction, rest assured.
You can, for example, review your company’s share capital to allocate a percentage of common stock to your succession and receive preferred stock for the fair market value of your business. As a new shareholder, the buyer can thus use the fruits of his efforts to redeem your shares.
Financing the buyback of your common shares can also be done after a specific period (or a little each year, until your shares in the company are completely repaid). In this type of arrangement, on the other hand, the capital gain exemption is not possible when redeeming the preferred shares, since it gives rise to a taxable dividend.
There are several scenarios for this type of transaction, but one thing is clear: making an appointment with a tax specialist is as important as negotiating financing. There is certainly a financial package that will allow you to have both your heart and your head in peace.