Mark Pestronk
Q: As I near retirement, I'm thinking of selling my agency to a small group of executive-level employees. If I sell, how can I establish the selling price, and how should the employees pay me? What if they stop paying me? Alternatively, I could decide to give the agency to them in return for promised annual income. If I decide to do so, would I owe any gift tax?
A: You could establish a selling price in several ways. First, you and the group of employees (acting together) could agree on obtaining a professional evaluation. Alternatively, you could pick one evaluator, the employee group could pick another evaluator, and then you could compromise somewhere in the middle. Finally, you could simply name a price, and then the employee group could get its own professional evaluation. If the evaluation is more than your asking price, the employee group could simply agree on the price you named.
The harder part is probably establishing payment terms. Assuming that the employee group could not pay you in one lump sum, which is probably a very safe assumption, the key is compromising on a number of years that is short enough to avoid risk yet long enough to be affordable to the employee group.
A related and equally difficult part is deciding whether the payments should be fixed or geared to the future sales, revenue or profits of the business that is sold. The latter formula is called an earn-out.
A typical set of earnout installments for a sale to a third-party might be 25% at the closing, with the rest set as a percentage of revenue over a period of about two or three years. However, with a sale to an employee group, the number of years could be longer to enable the employees to generate enough profit to pay you.
In my experience, a sale to an employee group carries a greater risk of nonpayment than a sale to a third-party such as a larger travel agency. To help minimize the risk, you should take a lien or security interest in the assets of the business, so that you could repossess it if the employee group defaults.
Alternatively, if you sell the stock of your corporation or the equity of your limited liability company, you could take a lien on the stock or equity until you are paid in full. Finally, if the employee group sets up its own corporation or LLC to buy the agency, you could insist on personal guarantees from each of the owners.
Of course, in appropriate cases, it may not be necessary to take steps to minimize the risk, if you trust that the employees will be able to run the business as well as you do. Such an approach may be particularly appropriate if you are already an absentee owner.
Giving away the business in return for a lifetime stream of income could also be a viable option. This year, the lifetime exemption from federal estate tax is $15 million per donor (or $30 million for married couples). However, there may be state gift taxes, and you would need to work with a estate and gift tax attorney in your state.