By Barry Carus, Esq.

The decision if and when to retire and sell your interest in a private and/or family owned business is a decision many business owners grapple with at some point during their careers.  People who have reached a certain point in their lives may wish to pursue other interests, but there are many factors to consider and business owners would be well served to consult with experienced accounting/tax, legal and financial planning professionals prior to notifying their partners that they wish to retire and/or pursue the sale of their ownership interest.

The process of planning and developing an exit strategy for business owners often begins with the negotiation and execution of the business’ governing document, such as a shareholders agreement for a corporation or an operating agreement for a limited liability company.  These agreements generally set forth the rights, duties and obligations of the “partners” regarding a multitude of issues, including the composition of the board of directors; the appointment of officers; decision making authority for both routine and extraordinary matters; restrictions on transferability of shares; and various buy-sell purchase options, including upon retirement, death and disability; and valuation of the business in various buy‑out situations.   Notwithstanding the inclusion of customary valuation provisions in such agreements, the decision by a partner to retire or the decision by the other partners to request a partner to retire, may open the door to negotiations as such agreement, although likely well planned and drafted, may not have been updated by the owners for many years and thus may not account for changes in the business’ valuation.  In addition, other factors may not have been previously considered such as the ever increasing cost of providing healthcare to the retiring partner, and the ability of a retiring partner to maintain his lifestyle which may be challenged (and require the retiring partner to make certain adjustments), when trading his annual compensation, perquisites and share of profits for a lump-sum payment or installment payment payout together with possible severance/consulting/salary continuation payments.  Engaging in this analysis at an early stage is crucial on many levels, including seeking to avoid the emotional toll that protracted negotiations may have on the parties which could result in fractured relations and potential business disruption.

A business owner considering retirement often has not given enough thought to these issues and others such as the loss of business stature and control which comes with retirement.  From the business’ perspective, the natural progression of ownership and management transition in a private and/or family owned business, if handled strategically, methodically and gracefully, may be critical for the long-term viability and prosperity of the business.  If everyone is aligned in this process, the goals of all parties may be attainable, but if not, the business can suffer from a lack of clarity regarding its short and long term business plans.

While the financial planning process is critical for the retiring partner, the remaining partners and the business, their respective interests may diverge in terms of economic and tax planning for the buy-out so the retiring partner should prepare by retaining his own accountant/tax advisor, attorney and financial planner at the outset.  It is incumbent upon these professionals to analyze if the person’s current and projected future financial situation will allow him to pursue a sale (or, if not currently, then when in the future), and under what terms such a sale may be feasible.  Only once this analysis is completed will the retiring partner truly be prepared to engage in meaningful discussions and negotiations with his partners.  While these steps will obviously require an upfront investment by the retiring partner (or perhaps may be funded by the business), it will be a worthwhile investment and likely reduce the overall transaction costs for all concerned.  Once there is a clear picture of the retiring partner’s financial needs, the parties and their respective professionals can move forward in negotiating a mutually acceptable term sheet to serve as a blueprint for the document preparation phase of the transaction. 

Issues requiring discussion and negotiation in a partnership buyout will include the purchase price; the breakdown of the purchase price between purchase/redemption of equity (generally more tax favorable to the seller) and consulting/severance/salary continuation payments (generally more tax favorable to the business); who will be the buyer (e.g. one or more of the other partners or the company); interest rate on unpaid principal if the purchase price is to be paid in installments; the financing source for the payments (e.g. from internal cash flow or an external financing source – depending upon the in-house managerial resources available to the business, it may be possible for the business to transition the retiring partner’s responsibilities among one or more people and use the cash flow saved on compensation to make the required payments to the retiring partner – but reciprocally, if the business requires an outside replacement, this may impact how much the business can afford to pay annually and the length of time the business will need for the payout, which could increase the seller’s risk of receiving full payment); security for any installment payments (this issue requires careful planning and analysis particularly if the business utilizes outside financing); providing health care to the retiring partner and his dependents; restrictive covenants; and whether or not any business/affiliate owned real estate is included as part of the transaction.

Owners are generally busy growing their businesses and don’t always devote the time and resources necessary to surround themselves early on with experienced professionals who can assist them in adopting long range plans for a multitude of scenarios, including the potential sale of the business or partner buyouts whether due to retirement, death or disability.  The underpinning for any of these scenarios is the adoption by the business of solid financial practices so the business is able to generate meaningful financial reports and statements that not only ownership and management can rely upon for periodic financial analysis purposes, but also can be used by the business’ professional advisors when seeking to value the business for potential sale or a partnership buyout.  If these financial practices are established and maintained, it will surely enhance the ability of the potential retiring partner and his professional advisors to answer the question, “to retire and sell or not to retire and sell”.  Indeed, if the answer is “yes”, then by following the above guidelines, the likelihood of all parties agreeing upon a workable transaction structure and consummating a transaction in a collegial manner is significantly enhanced.