How to Fund the Sale of a Business in a Generational or Internal Transfer

July 12, 2022

As business owners age, business succession planning becomes increasingly important. Many business owners dream of leaving their beloved businesses to their children or grandchildren and keeping their life’s work in the family. However, those same owners often count on the sale of their businesses to fund their retirement years—and because their children or grandchildren likely don’t have the assets (or credit) to actually pay them an amount equal to the value of the business, it may seem as if their dream simply won’t work.

If you’re in this dilemma, don’t worry. It’s possible to transfer your business to a family member or internal employee without requiring him or her to outlay cash, while you still profit from the transition. The best way to do this is with a progressive step acquisition. This type of sale allows a new owner to gradually increase his or her ownership of the business over time, and allows the seller to gradually monetize the sale of the business over a period of several years. It’s the ideal approach to business succession planning for those who want to keep the business in the family. 

How does a progressive step acquisition work?

With a progressive step acquisition, a key person (such as the owner’s child or grandchild or a current managerial employee) takes the reins and a small percentage of ownership. He or she grows the business, making more money over time. The seller still owns a portion of the business and is able to participate in and benefit financially from that growth, but he or she no longer owns all the risk. 

Over a set number of years, the seller’s share of the business gradually decreases and the new owner’s share gradually increases. This can be accomplished with various vehicles including gifts, bonuses or capital contributions funded by their minority share of Corporate profits. 

When the new owner reaches about 40 percent ownership, most sellers undertake a full distribution for the balance of their ownership. At this point, the seller receives a lump sum payment for the rest of the business.  This is generally funded from bank financing.  The whole process usually takes 7 to 10 years.

The seller takes a portion of the business’s earnings throughout the transition period, but he or she is no longer responsible for managing all the risk or the day-to-day operations of the business. When the transition is completed, the seller takes his or her full distribution. Because the business grows and increases profits during the transition period, the seller takes significantly more out of the business than if he or she had sold it outright.

Answering objections

Some owners reject a progressive step acquisition because they think it seems like they’re “getting paid with their own money.” However, if you’re selling the business, it’s not your money anymore. As soon as the new owner is involved, you are no longer responsible for all the risk. And if you’re able to let go and allow the new owner to manage (or share in) business operations, you’re also no longer solely responsible for the day-to-day work. If the new owner grows the business as planned, you benefit from his or her contributions without having to run the business and manage the risk on your own. 

If you’re planning for business succession, you’re likely committed to the future of your business as well as your own personal financial future. Most business owners who choose a progressive step acquisition aren’t doing it only for the money. If your goal is to keep your business in the family or with another person you care about, a step acquisition may allow you to do that while still benefiting financially from the sale.

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