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"Cashing In When Cashing Out"

October 5, 2011

By: A. Lee Lundy, Jr.

October 5, 2011 (Baltimore, Maryland…) Lee Lundy, a partner in the firm’s Business, Corporate and Tax Department hosted a roundtable discussion for business owners. He was joined by John Cogar, Wealth Planning Director and Senior Vice President of PNC Wealth Management. Here is a summary of the discussion:

Both Lee and John know that as business owners look to the future, they envision selling or otherwise passing their business to the next owners/managers. This assumes a voluntary "cashing out." Before Lee and John delved into the voluntary cashing out or "Plan A," Lee took a look at the highly recommended other arrangement – Plan B – for any involuntary cashing out – as it should to be in place in case owners need it before they fully implement Plan A.

An involuntary cashing out plan, due to death or disability, provides for that unforeseen event – and should be in place now. Business owners should have a buy-sell agreement that includes triggering events, pricing, and payment terms. If they don’t have one, they should focus on this first. Although it should dovetail with Plan A, the business owner should implement it now and dovetail it later when they know what Plan A will entail.

Plan B should also be written to cover retirement or one partner who is just heading for the beach. It should cover any departure, particularly if the business has owners holding small percentages.

So, once Plan B is in place, it is time to look at the voluntary cashing out – Plan A. "Cashing in" implies that a business owner will get money for his interest. Some components to the plan could combine gifting and selling. As a general rule, the next owners should also be managers to reduce issues on who takes what risks and who gets what rewards. Plan A should take into account the buyer, the implementation process, pricing, source of funds, and security.

Is the buyer family? Employees? A third party? The answer will help shape the plan that is put into place.

Selling to Family. Do they want to buy you out? Are the family members able to run the business? What is the timeline? Will they need training, coaching, or new non-family specialist managers to effectively keep the business profitable? Can they work together? Have roles and responsibilities between them been delineated and communicated? Who will hold what authority? How will disputes be resolved? Is the family as a whole in agreement as to who is in and who is out?

Selling to Employees. Many of the same questions about willingness, ability, and functioning apply in this type of buy out. How soon do they get some stake in the business? When they get a stake, what voice do they get? Will they go on the line to support funding the buyout?

Selling to a Third Party. Is the business saleable to a currently uninvolved party? Have all the issues (minimizing post sale indemnification issues and removing non-business assets) been cleaned up? Will they pay the price, and how will that be structured?

Pricing/Source of Funds. No matter who is buying, a first step is the pricing – which may require an appraisal. Next, the source of funding needs to be considered, as well as any security for deferred payments. If selling to employees and family, they probably do not have ready cash. Can the business support installment payments plus salaries to new managers/owners? Are there other current owners that will also need to be bought out? If so, layering, timing, and co-ordination on management will need to be considered.

If selling to a third party, how much can be obtained up front? How much in earn-out? Is post-sale involvement required?

Managing the Process. Your lawyer and financial advisor can advise you on sound practices when preparing to cash out. They can also steer you away from the common – and uncommon – pitfalls that are a part of the process. They can support you on:

  • what rate of payout (or debt payment) the business can support
  • business structures
  • agreements
  • estate planning
  • taxes
  • negotiation, maybe even with your family

Solutions for you will depend on your goals and individual situation. To learn more about your options, contact Lee Lundy at 410.752.9705.

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