One difficult aspect for those who own small or family businesses is how to get out of that business and get something back for it in return. For those whose business is marketable to a third party, selling the business is alluring. There are obvious legal issues to protect oneself in that transaction, but that topic is not the purpose of today’s column.

 Many business owners, particularly in today’s economy, don’t have the opportunity to sell the business for what it’s really worth. They also have difficulty finding someone who won’t run the business into the ground. On more than one occasion I’ve seen clients turn to their employees as the logical choice to carry on the business.

 The existing employees might just be the best candidates to take over a business from the retiring business owners. They know how it runs. They may even have ideas how to improve it. But there are dangers. Usually the employees don’t have the capital it would take to buy the business form its owner. Moreover, there is a big difference between working the 9 to 5 shift and actually running a business.

 Yet it can be done successfully.  Today I’m going to outline various issues that one might want to address when turning over a family business to employees:

 First, determine the employees’ level of interest in taking over the business. Is this something that they would look forward to? Are they cut out to run the business? Are they savvy enough to not run it into the ground without your continued input?

 Next, determine the true value of the business. A qualified business appraiser or CPA with valuation credentials can properly value the business. Owners tend to over value the worth of a business while buyers want to pay the least amount possible.

 Third, come up with the means that will be used to finance the sale. This is often the most problematic aspect of transferring a business to employees. Employees often don’t have the cash that it would take to buy the business outright from the owner. If the owner takes back a note, even if that note is secured by business property, he runs the risk that the employees gut the business and that all value is lost.

 If there’s room to borrow against the assets of the business, the employees could take out a loan and transfer the proceeds as a down payment. The owner can invest the down payment in an annuity or life insurance product that will guarantee or provide income that serves to replace the lost income from the business itself.  The remainder of the purchase price can be structured in a loan between the owner and the employees. Additionally, or in the alternative, the business can enter into a consulting agreement with the owner that pays him for a specified period of time.

 Using life insurance to structure a deal has been helpful. With today’s life insurance and annuity products available, the employees can agree to pay a sum certain into the policy for a period of years building up its cash value. At some point the policy is then turned over to the owners. This effectively leverages the employees’ output while providing a set amount of equity to the owner.

 There are a variety of ways to tackle the problem. Some have more advantageous tax consequences than others. Good legal and financial professionals can help guide you through many creative alternatives that might be available.

 ©2009 Craig R. Hersch