Four alternatives to family succession

If you have a family-owned business, the biggest problem you’ll likely face when it comes to identifying a successor is choosing who will fill which role. But if you’re a business owner with no other family members, or none interested in taking over the business, then deciding who to pass the company on to becomes more difficult.

The two main options are to sell to a person or group currently with the business, or to sell to an outside party. There are advantages and disadvantages to either approach.

An employee share/stock ownership plan (ESOP) is frequently used to pass on ownership to people who currently work in the business. An ESOP is a tax qualified deferred compensation employee benefit that makes employees of a company beneficial owners of stock in it. While they can be used for a number of purposes, the ESOP Association — the national trade association for companies with employee stock ownership plans in the U.S. — says ESOPs are most commonly utilized to buy the stock of a retiring owner in a closely held company.

When used for this purpose, an ESOP receives stock from the owner and then those responsible for managing the ESOP put some of the stock in individual employee accounts held by a trust. In U.S. law, a trust is not a person, but a legal entity that holds assets for others, and is managed by a third party — called the trustee — who must do things in the best interest of those who will benefit from the trust.

The advantages of using an ESOP for succession is that it helps ensure the continuation of the business and provides employees with a greater interest in its success – as owners. The disadvantages are that it can be costly to implement and subjects the ESOP to IRS and Department of Labor regulations designed to make sure participants are treated fairly during the purchase. The selling price may also not be as high as it would to an outside buyer.

Another option for succession, used less frequently, is a management buyout. In its simplest form, an MBO involves the management team pooling resources to acquire all or part of the business they manage. A Leveraged Management Buyout (LMBO) is similar to a MBO, except that the buyers use company assets as collateral to secure financing. Most of the time, the management team takes full control and ownership, using their expertise to grow the business.

The options for selling a business to an outside party often come down to either a financial or strategic buyer. If the business attracts a financial buyer, chances are greater that the company will continue in its present form with a new owner. With a strategic buyer, however, the business is likely purchased by a competitor or other ancillary business, which could mean quite a bit of change for employees as consolidation occurs. Jobs can be eliminated and/or people sometimes leave on their own as they find it difficult to embrace the new way of doing things. But selling to an outside buyer often brings the highest price for the seller.

When unable to fetch an asking price they think is fair, or maximize their return on investment, some owners, instead of selling the business outright, opt to maintain a stake in the company while at the same time stepping away from the day-to-day operations of it. A professional management team can be brought in – or developed internally – to run the business in the owner’s absence.

As with all decisions surrounding succession planning, none of these steps should be taken without careful consideration. It’s always best to seek the advice of financial advisors, accountants, tax experts, etc. These decisions are some of the most important you’ll ever make.