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Business Succession Planning

Published: 3rd December 2018

Author: D H Lawyers

Published in: TrialBalance December 2018 Issue 65

Management Buy-outs and Selling Shares to employees

Succession planning is an essential consideration for all businesses, especially where the owner is considering exiting from the business within the next 5 years. When the owner of a privately held business is looking to move on, there are several succession planning options that they may choose to take. Generally, the owner will approach a business broker and sell to an unknown third party; or perhaps they will contact others in their industry to see if a competitor wishes to buy them out. Alternatively, they may choose to sell to someone already working in the business, through either Management Buy-Out (MBO) or the sale of shares to existing employees.

Below we will discuss both Management Buy-Out (MBO) and the sale of shares to employees as succession planning approaches, and look at the importance of structuring them correctly to protect the owner’s interests.

Management Buy-Out (MBO)

One option for a business owner is to sell their company to one of the business’ existing management team or other senior employees. If one or more of the managers or other senior employees buys the business, this is often referred to as a Management Buy-Out (MBO). The advantage of an MBO is that the owner will be selling to people that they have confidence in. The buyer will most likely already have relationships with customers, suppliers and staff which can make the transition much

smoother. Owners often build up a business over many years and genuinely care about their customers, staff and others that they have a business relationship with. The owner will most likely know the buyer well and have confidence that that person will know these parties and be able to continue to nurture and develop these existing relationships.

To make the transition to new ownership smoother, the current owner will often agree to provide support to the buyer, usually by contracting to provide services back to the company for a fixed period of time.

Share sale to employees

Another succession planning option is to sell just some of the shares in the company to an existing, usually senior employee, and for the owner to retain the majority of the shares in the company. Then over time, the remainder of shares can be transferred to the buyer. The right to buy further shares can be based on financial or other targets set by the purchaser, or the company as a whole. An advantage of selling to an employee is bringing in someone, generally younger, with enthusiasm to run the business. They are then able to increase the value of the business with new ideas and hard work and the existing owner benefits because they still hold the majority of the company’s shares.

Structuring the transaction to protect the owner’s interests:

In either a full sale by MBO or sale of only part of the company to an employee, it is possible for the owner to let the purchaser pay off the shares they have purchased over a period. This is referred to as “vendor finance” because the seller of the shares (the vendor) is effectively providing finance to the purchaser until the shares have been paid for in full. An advantage of vendor finance is that it can enable a purchaser who otherwise may not be able to afford to buy shares in the company (e.g., because they have recently financed a house purchase) to participate in the transaction. Vendor finance is often provided in conjunction with some bank funding which enables the owner to receive a portion of the purchase price (the bank-funded part) immediately at the time of the share sale

When vendor finance is provided, it is usual for the owner of the shares to take security over those shares until they have been fully paid for. This means if the purchaser of the shares were to default on their payments, the owner would have the ability to take back the shares. The security can then be registered on the Personal Property Securities Register to give the owner priority over subsequent secured parties.

If shares are sold to an employee, and the owner is retaining an interest, it will be vital that a Shareholders’ Agreement is prepared to set out the rights and obligations of both parties. This may include things such as:

• matters that require the approval of all shareholders;

• what happens if a shareholder gets sick or dies;

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