The sale of a family-owned business can be an emotional time. This could be a business that has been in your family for generations and now you are finally selling it on the open market. On the other hand, you could sell the family business to another family member so you can keep the business within the family and maintain its legacy. There are pros and cons to each one of these possibilities. If you are thinking about selling your company, you need to know the tips, tricks, and traps of selling on the open market and selling to another family member. Only then will you be able to make the right choice for your own unique situation.
Selling Your Business to A Family Member
The idea of selling a family owned business to another family member might sound like a good idea. After all, you don’t have to waste time hiring a broker and trying to sell the business on the open market. That can take months or even years before you find a buyer. And if you do find a buyer, you’ll have to pay brokerage fees out of the earnings you get from the sale. Worst of all, you have to trust a complete stranger with running your family business after it is sold to them. A lot of people take pride in their family business, which is why keeping it within the family by selling to another family member might seem like the best way to go. That way, you’ll have a buyer readily available who you can easily negotiate with and trust. On top of that, you can make it a private sale without needing a broker or middleman to handle the transaction. This means no paying brokerage fees or any other administrative costs.
Most business sales from one family member to another usually involves installment payments. These are basically monthly payments that the purchaser will make to the seller. In the meantime, the purchaser will get to run the business and take in the profits. But they will also be responsible for the expenses as well. Since the buyer and seller are both family, the seller will likely trust the purchaser in making those payments without having to do a credit check on them or anything like that. Of course, there will be a promissory note created on record by the seller which outlines the agreement of the sale between both family members. This promissory note is what makes the transaction official in case there is a dispute about ownership in the future.
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As simple as it sounds, the one big negative consequence that could come from selling the family business to another family member is the substantial income tax the can be incurred from it. If you are selling the business for cash, then you’ll just pay a capital gains tax on the total net profit that you’ll receive from the sale. That is why most sellers would rather do installment payments because it means they won’t have to pay any gift taxes or substantial capital gains taxes. Best of all, the family member purchasing the business doesn’t need to come up with a lot of cash right away and you can take the burden of running the business off your shoulders and put it on theirs. So, it is really a win-win situation for everybody.
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The big setback to installment payments from a family member would be if the seller dies during the course of the contract. For example, let’s say a father is selling his business to his son. They both agree that the son will make monthly payments to the father over the next ten years. Unfortunately, the father dies five years later and the deal is not completed. In the father’s will, he forgives all the outstanding debt that the son owes on the promissory note. This means the son doesn’t have to pay that debt and gets complete ownership of the business. However, it also means the son will have to pay a capital gains tax on the amount of debt that was forgiven because this forgiven amount is considered as income (since the son didn’t have to pay it).
Selling in the Open Market
When you sell your family owned business on the open market, you are basically going to be selling your business to a complete stranger. The upside to that is you won’t have to feel guilty about asking for an amount that is above the value of the business. As long as the business has potential to grow and make money, it is easy to ask for a sizeable amount of money if you can prove the business makes good profits. If you were to sell the business to a family member and ask for a lot of money, it might offend them because you are part of their family and it’ll look like you’re just trying to profit off your connection to them. This will create ill feelings between you and your other family member, which is something neither of you would want. So, if you want the potential to make a big profit off the sale of the business, then sell it on the open market.
As for the downside of an open market sale, you will have to do a credit check on the buyer if they want to make installment payments for the purchase of your business. You might think they could just get a bank loan and then pay you with the loan, but it doesn’t work that way in business sales. Banks will usually lend money to people who are looking to start a business, not purchase one. Although some buyers with a huge credit history may qualify for a bank loan to purchase a business, most buyers will not. That is why they will either offer you cash or the promise of making monthly payments to you.
In the event that you accept the monthly payments option and perform a successful credit check on them, you’ll have to create a promissory note and then hand over your business to them. The big risk here is they could stop making payments on the note and then you’ll have to spend money on lawyers so you can take them to court and get your business back. By the time that happens, your business could be ruined if the buyer did not manage it properly. So, you could end up losing either way if the buyer fails to deliver. Therefore, always do your homework on buyers by not only researching their credit score and credit history, but also their history of running and purchasing businesses as well. Don’t ever accept installment payments from someone with a weak credit history or with no experience running a business. Instead, go with buyers who have a proven track record of successful business transactions and operations.