Key Considerations to Successfully Transition the Ownership of Your Business

Business ownership transitions are back on the table. After a long lull following the recession, a growing number of company owners are looking at how best to sell their business, turn it over to the next generation, or offer their employees a buyout opportunity.

In the following conversation, Michael Jamieson, Executive Vice President-Director of commercial banking of Old National Bank, explores the different ownership transition options. 

Why are business ownership transitions picking up?

Jamieson: The recession brought the natural transition activity to a halt which created pent up demand. Now that the economy has improved, so have company valuations, and owners are again considering the best options for transitioning ownership.

We also observe business owners, who are part of the Baby-Boomer generation, are increasingly undertaking a transition planning process as they assess what’s next for them in their careers and personal lives. By most research accounts, the number of Baby Boomers who own a business is in the millions, with over half of the owners expected to retire during the next couple decades. 

What are the options?  

Jamieson: Our client base is predominantly family owned businesses. Most owners start out wanting to transition ownership to the next generation. Before doing so they need to consider a number of factors to determine if this is the best path for the company. Does the next generation have interest in running the business? The talent? The grit and determination to take the company to the next level? Is the next generation in alignment in terms of the future of the business? 

A recent survey by the Family Business Alliance found that only 1/3 of all family owned businesses will make the transition to the second generation. Only 12% will make it to the 3rd generation and less than 3% will make it to the 4th generation. That suggests that the majority of these businesses are sold to third parties which could be private equity or strategic buyers within their industry. 

Another option is an employee stock ownership plan (ESOP). Under this scenario the company is sold to its employees. About 1% (over 6,700 nationwide) of companies pursue this option. Old National recently added an experienced ESOP team to help our clients walk through this process to see if it is the right path for them
to take.

How does a business owner start the transition process? 

Jamieson: First, business owners need to determine their financial and non-financial goals. Financial goals primarily relate to the financial liquidity arising from selling a business: how much and what is the timing of cash an owner needs/wants to receive from the transition process? The tax impact of the transition process needs to be factored into this assessment. Non-financial goals include assessing questions such as “do they want the company to remain independent?” Does the owner want to remain actively involved in business for years to come or prefer more limited involvement such as serving as a director? What legacy do they want to leave behind? Should the company remain in the family? Does the next generation have the desire and skills to run the business? 

When should transition planning begin?

Jamieson: Most entrepreneurs are so involved in their businesses that they don’t spend enough time thinking about transition. But the ones who do it well start the process 5-7 years before they are ready to execute on a plan.

What’s the best way to finance the transition?

Jamieson: If the company is not going to be sold, there are options to consider. At Old National, we typically prefer to collaborate with the owner’s other business advisors to develop financing for a capital structure; this includes working with the owner’s attorneys, accountants, tax and investment advisors involved in the business and estate planning aspects of the transition.  Alternatively, we can structure a recapitalization or mini-buyout that provides the owner/seller with cash along with a note to be repaid over several years. The level of leverage and repayment terms will depend on the business owner’s need for immediate liquidity and is one of the reasons why assessing the owner’s liquidity goals is such a critical initial step to beginning the transition process I mentioned earlier. Some owners who have planned ahead and saved for retirement may elect to structure the sale on an installment basis where 100% of the proceeds are received as a note to be paid over time or forgiven. Other owners may need some or all of the cash up front. 

How does an ESOP structure work?

Jamieson: Broadly speaking, financing for ESOPs comes from a combination of bank loans and notes due to the selling owner; some are entirely owner-financed with the owner taking payments over time. Most ESOPs include a combination of both bank and owner financing.  

Is there a type of company more appropriate for an ESOP?

Jamieson: The best ESOP candidates are non-cyclical businesses or ones without a need for big capital expenditures. ESOPs need consistent cash flow in order to be able to repay the seller and bank loans.   

What are the tax benefits of an ESOP? 

Jamieson: One ESOP structure enables the owner/seller to defer the capital gains tax on the sale of their appreciated stock. For example, under current tax laws, if a company’s stock has a cost basis of $1 and is sold for $10, the owner/seller pays capital gains tax on the $9 profit. But under this ESOP structure the tax on the gain is deferred indefinitely as long as the proceeds are invested in qualified securities. In this example, owner decisions are often made in conjunction with an estate plan.  

Also, the ESOP is very tax efficient for the company. For example, the business may be able to take a tax deduction for both the interest and principal loan payments on ESOP debt, unlike traditional loans where only interest payments can be written off. Another benefit worth serious consideration during the transition planning process is structuring the sale as an S-Corporation ESOP which results in the business being exempt from federal, and in most states like Illinois, state income taxes.  

A few moments ago I mentioned at Old National we typically prefer to collaborate with an owner’s other business advisors to develop and provide financing for a capital structure which supports the owner’s financial and non-financial transition goals: these benefit examples also provide a little more insight into the importance of an owner’s advisors collaborating to develop, implement, and periodically update their transition plan.

How can Old National help?

Jamieson: When a business owner starts to get serious about a transition, they’ll usually engage an independent advisor to walk them through the alternatives. At Old National, we stay close to our clients to understand their goals. We can offer our analysis along with financing solutions from structured loans, recapitalizations and leveraged buyouts to ESOPs. The finance professionals at Old National Bank act as an owner’s trusted advisor to help create and execute a plan which results in a smooth transition and rewarding legacy. 

Michael Jamieson
EVP - Director of Commercial Banking
Old National Bank - Chicago
708-831-7334