Workplace

Many business owners believe an external sale of a business is the only (or at least the best) exit option. Typically, this is because business owners recognize their employees or family members are unable to finance a business acquisition. So exiting owners often think they need to sell their businesses to outside buyers to meet financial goals.

However, internal business transfers also offer benefits, and exiting business owners should consider both options.

Pros

There are three primary differences between internal and external business transfers. First, the driving force behind an internal transfer is a business owner's motive to pass the business to someone internally rather than to an outside buyer. Second, in internal business transfers, business owners frequently consider tax planning and estate planning along with exit strategies because internal transfers, as a general rule, allow for more flexibility in these areas than external transfers. And third, corporate assets, including future cash flows, are leveraged differently in an internal transfer.

There are numerous internal transfer methods, including employee stock ownership plans; management buyouts (sales to family and management); and gifting strategies, including private annuities, family limited partnerships, charitable transfer strategies, etc.

A business owner considering an internal transfer can set the transfer's price and terms and tell his or her family and/or management team what he or she wants or needs for the business. For this reason, internal transfers often are referred to as "controlled transactions" because the business owner works with assets he or she already possesses in structuring the business exit. If those assets are sufficient to achieve the owner's goals (based on his or her motives), it is worthwhile to consider an internal transfer. Internal transfers are more common than external transfers in the construction industry.

An external transfer often subjects a business owner to a due diligence process that includes outsiders investigating their potential investments in a business and telling the owner what they are willing to pay for that business. The exiting business owner can expect to lose quite a bit of control during the process.

According to many mergers and acquisitions professionals, in the event an owner wants to set a deal's price, the outside buyer likely will set its terms. A deal is made when each party is equally happy.

Cons

So what are the downsides of an internal transfer? Quite simply, negotiating with family members and key employees can be uncomfortable. These individuals (and their advisers) require detailed and confidential information from the business owner to fully understand all the risks inherent in owning the business—similar to an external buyer's due diligence.

The most cautious first step a business owner can take is to engage an intermediary, which can be any of the business's advisers or an exit planner, to assist with the transaction. Having trusted advisers and professional reports helps raise objectivity and lower emotions when negotiating a transfer.

Another downside of an internal transfer is the loss of potential for extraordinary gain.

As a general rule, external buyers for businesses include strategic (or industry) buyers and financial buyers (such as private equity groups). A strategic buyer stands to offer the seller the highest total value for the business because that buyer can apply "synergies" to the valuation of the deal. In other words, a buyer who is in the same business as the seller can eliminate duplicate expenses and acquire new customers for existing products.

Know your options

If you want to exit your business, be aware of the various exit methods. Knowing the pros and cons of internal and external transfers, as well as your specific values and motives, is critical to establish a proactive and successful exit strategy.

Kevin J. Kennedy is president of Beacon Exit Planning, Elmira, N.Y.