By Rayanne Buchianico, ABC Solutions, LLC
This is the fifth of a multi-part series on exit strategies authored by Rayanne. Click here for part one, click here for part two, click here for part three, and click here for part four.
In this final article of the series, I will outline one of the more difficult solutions to selling your business. This solution is not for everyone. It takes patience, trust, and most of all, cash. There is, however, a bit of flexibility in this solution.
Consider the possibility of selling your ownership back to the company. This can only work in a corporation environment. Sole proprietors and disregarded LLCs have no one to sell to but themselves. Partnerships and multi-member LLCs require the approval of all members for such a transaction, but it could happen. In a corporation, you own shares of stock. You can sell that stock back to the company. This will open those shares and make them available to others for purchase.
CWD Technology, Inc. is a Subchapter S Corporation. The sole shareholder, Lou, owns 1,000 shares of stock. Lou is ready to retire and wants to pull his retirement fund from the company. The business has grown in recent years and he believes it is worth $750,000. That is what he wants from the business.
Jim is a long-term, loyal employee of CWD Tech. Jim is interested in buying the business, but does not have, and cannot get, $750,000. He can scrape together about 10 percent of that amount. Lou sees an opportunity and they begin negotiations.
Lou decides to sell his stock back to the company at a premium — $750 per share. He has 1,000 shares. Once he sells all the stock back to the company, he will have received his full $750,000. The company, by way of corporate resolution, agrees to purchase the stock and place the stock back into the treasury.
Jim offers to buy the stock from the company. He will buy the first 100 shares at the $750 per share premium, buying into the company for $75,000. The remaining 900 shares will be purchased at a discount for $10 per share through a payroll deduction.
At the beginning of each year, Lou sells 120 shares of stock to the company for $90,000. At the same time, Jim purchases that stock for $1,200. This agreement stretches on for seven-and-a-half. Each year, the company siphons $90,000 to pay for Lou’s stock and never recovers the money from Jim. In other words, the company is funding the buy-out.
In order for this to work, the company must make money, as well as have a solid cash flow and bank balance. Otherwise, Lou would ultimately bankrupt the company.
Lou doesn’t want to give up control over this agreement, even after his stock ownership drops to under 50 percent. The two men sign an agreement that limits Jim’s voting rights until Lou is paid in full. On closing day, the money in the bank accounts belong to Lou. He closes the company accounts and a new one is opened. Lou lends the company $50,000 in operating funds and Promissory Notes are in place to repay the loan. An escrow fund is also established to ensure six months of payments to Lou in the event the company struggles with maintaining cash flow.
You can stretch this option as far into the future as you want. If your company cannot afford to pay you off in five or seven years, extend it to 10. Both parties have every motivation to make this work since they are both financially invested. If you follow this structure, you want the buyer to invest money into the company. The buyer will need basis in the stock and that can only be accomplished through cash buy-in or profits. The company should not give away stock for free.
You can skip a year if the company is having cash-flow problems. You can sell the stock to more than one person if you have two people interested in buying the company together. You can escalate the sale if the company has the cash to manage it.
Spreading the sale over multiple years keeps the capital gain from landing in one year on a tax return. This spreads out the tax liability. This does not reduce the tax, but it may be more palatable in smaller doses.
This solution is not without risks. The company may have a decline in revenue and may not be able to maintain the original agreement. Have a backup plan and remedy to save the company. No one should be left with all the risk. For instance, if revenue dips below 70 percent of the revenue in the starting year, begin taking drastic measures to recover and place the stock purchase plan on hold. Do not ride out a storm when there is a hole in the bottom of the boat.
Alternatively, the company may have an unusual growth spurt. This is great news for the agreement but may also trigger the buyer to want to stay on and reap the profits during the wave. Have a set schedule for the buy-out and do everything in your power to stick with it.
As you have seen in this series, there are many ways to structure your exit strategy. Keep your options open and use creativity to structure your exit your way. Communication and planning will be your best friends. Lawyers and accountants are helpful, too.
About The Author
Rayanne Buchianico owns and operates ABC Solutions, LLC, an accounting, tax, and business systems consulting firm serving all industries and specializing in IT firms throughout the United States. She is also a partner in Sell My MSP, a listing service connecting interested buyers with motivated sellers of IT firms. Rayanne is passionate about nurturing the transformation in owners of small businesses who become more comfortable and savvier with the financial aspects of their business.