"Flipping" a Business, and Buying One from a Retiring Founder by Cliff Ennico on Creators.com

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"Flipping" a Business, and Buying One from a Retiring Founder

"I have made an offer to buy an existing small business in my town. The owner is in his 70s and has let the business run down the past couple of years, but I see a lot of potential for quick growth. My objective is to buy the business, have a manager run it for a couple of years and then sell the business at a profit. I have a manager in mind, and I'm willing to compensate him generously since he's only going to be doing this for a couple of years, but he's concerned that I'm going to fire him right before I sell the business and cheat him out of his share of the sale proceeds. What's the best way to put his mind at ease so that he gives the business the time and energy it deserves?"

You really wouldn't do that, would you?

Seriously, in these difficult times, you should not be surprised or offended that your manager is already thinking about ways you can cheat him down the road. He's probably been in this situation before, and "once burned, twice shy."

Since you have "tipped your hand" by telling him of your plans to "flip" this business, you should consider giving him a healthy share of the profits, as well as a base salary and perhaps also a commission on any new business he brings into the company. I would not, however, give him an actual ownership stake in the business, as you want to be the one to determine when it's time to sell the business, whether an offer is one you would accept and so forth.

You should ask your attorney to draft an employment agreement between your company and the manager, spelling out his compensation and stating clearly that if the business is sold while he is still an employee, he will receive, as a severance payment, a percentage of the "net proceeds" of the business sale (basically, the purchase price less the closing costs, such as legal and accounting fees and any brokers' commission).

The agreement should also provide that if the employee quits or is terminated "for cause" (for example, he is stealing money from the company) before the sale takes place, he gets nothing. However, if you terminate him for no reason and a sale takes place within X months after he is terminated, then he would still be entitled to his percentage of the "net proceeds" of sale.

That will give him the protection he needs while keeping you firmly in control.

"I have been offered a management position at a privately owned company with a single owner. As part of the offer, the owner and I discussed a partner buyout where I would take over the company (100 percent of his share) over a period of time. He has asked me to draft the proposal so we can come to fair terms. He is 55 years old and is looking for an exit strategy. We discussed a plan that would sell me 25 percent of his shares each year over a period of four years. How should I be structuring a buyout that is fair to all involved and minimize my outlay of cash for the opportunity?"

First, you should have someone — the company's accountant, for example — do a "quick and dirty" valuation of the business so you can figure out what the owner's shares are worth. This is important for two reasons: 1) Because the owner is selling you his shares, he will have to pay capital gains tax on the amount you pay for them; and 2) you will need to pay "fair value" for the owner's shares, and you won't know what that is without an independent valuation (if you pay less than "fair value" for the shares, there's a risk the IRS may treat the difference between what you actually paid and "fair value" as compensation for your services to the company — not a good thing, as you will have to pay taxes on this amount at "ordinary income" rates).

Once you know the company's value, figure out how much you can afford to pay each year and let that determine the buyout period. If the owner will be compensating you to run the business, consider deferring a portion of your salary and using that to buy shares from him each year.

Finally, make sure you have the right to buy all of the owner's shares at your agreed-upon price if the owner dies or suffers a permanent disability before you have bought his entire ownership position. If necessary, take out a life insurance policy on him so you can use the policy proceeds to pay the purchase price.

Just don't take out too much insurance, or else he'll insist that you be the one to start the car each morning ...

Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com.

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