Employee Buyout -EBO

If no one in your family will take your business over, you may want to consider passing it to directors or employees of your company.

Upside is that the person knows the business well. He has been working in the company for long. The education necessary to take over the business will be relatively mild.

The downside is money. He may not have enough money to buy out the business. Also, if your company has taken loans from banks, you are likely a guarantor of the loans too. The successor director/employee will be required to guarantee the loan instead of retiring you. That will be difficult for him to accept.

As to the money to buy out, if the company is performing well or has enough assets on its balance sheet and the successor seems capable, banks will be able to consider lending you money. Also, there are venture capitals or private funds that will provide you with fund to buy out the shares.

The company can also issues preferred shares without or limited voting rights to you so you will have right to receive dividends while the successor will have shares with voting right to control the company management. If the shares with voting right is only a small portion of the total shares, the money needed for buyout will be limited. According to the tax law, shares with voting right can be the same valuation as those without voting right. Therefore, if the majority of the existing shares are non voting shares, the valuation of the shares with voting right can be limited, based on the proportion.

But you still want to keep more than 1/3 shares that give you a veto, because the new management can issue new shares to dilute your shares and therefore reduce your right to receive dividends.

Points to consider

You should avoid giving shares to your employees for free. There will be gift tax. Gift tax can be higher than capital gain tax that you will have to pay in case you sell it. The gift tax can go up to 55% while the capital gain tax is flat 20.42%. Even if your intention is to give the shares for free, you will want to compare the both scenario carefully. You may be able to reduce the total tax amount paid by you and him by raising his salary for years and letting him buy your shares.

Not only family member but other can be the successor of you business

We would think that the business succession of SMEs is usually to pass it to his next generation in his family. That is still the majority of the cases but it is not always true. These days, there are more successions to directors or employees who are not from his family or selling to a total third party.

If you would like to leave your business to your heir, you will have to worry about the inheritance tax. You would like to know how to lower the tax.

If you would like to pass it to your employees or directors who have been working in your company, he must know the business and its relations like important suppliers and clients. It will be easier to carry on the day to day operation than heirs who can be new to the business. The typical issue is cash he has. If your company is big enough, the valuation can be easily higher than the amount a normal personal can afford to buy its shares. In typical situation, the person will set up a company and borrow money through the company, with security of the company assets backing the loan. If you have been the guarantor of the company loan, the employee successor has to guarantee the loan to replace you. That can be very difficult for him and you may need to negotiate with banks.

These days, M&A is becoming more common. You will get cash in return and that will probably be the most important advantage. Also, buyers should know that business or they are already in the same business industry. They will benefit from a synergy. There are many private companies that provide M&A consultation and matching service such as Nihon M&A Center or Strike. There is also a public sector service provider such as 事業引継ぎ支援センター. Japanese government is interested in keeping SMEs running and operating.

How to make your succession of your business successful

Many business owners should probably want to pass their businesses that they worked and built for their lives to the next generation. Successful succession of active businesses are also good for its stake holders such as those who work for the company, business partners and vendors, customers and the society.

Their typical concern may be:
What can I do to save any family conflict if I want to pass it to my elder child after my passing away but how will my other children feel about? Won’t they be unhappy each other?

Maybe, a will can help. But how can I structure it and what should I say in it?

“I would like to pass it to the employee that understands the business very well or I would like to give it to the husband of my daughter who has been working in the company for long time. But because they are not legal heirs, would there be any good timing or recommendable steps to take?”

“I would like to sell it to a third party. How can I find potential buyers?”

“If I give or sell the shares to the successor, how much tax will I or she have to pay?”

“Are there any good structures that reduce the tax?”

Legal structure or arrangement to the successor has to be carefully considered so it will pass meaningful control over the company. If the structure is poorly set, the successor may not have enough power to manage the company or may end up having to pay too much taxes.

A well designed succession requires expertise in legal, tax and other aspects, you may want to use the skills and experiences of those professionals.

In this blog, I would like to mention and explain possible obstacles and issues, points to consider and how to avoid unnecessary problems and provides tips get the best solutions you can think of from the circumstances.

Why you need to know your company valuation for its succession

Succession/Inheritance

If you own a business and you want to pass it to your children, you probably want to know how much tax you will have to pay for the transfer. It can be either a capital gain tax (if you take the form of selling), gift tax or inheritance tax.

Forms of succession

Some people just sell shares to her successor at market price. Some people set up a company with very little capital and borrow money from a bank to buy the shares. The successor (who can be her children or her relatives) will own the shares of the new company (holding company). If the existing business is profitable enough, banks will be willing to lend money to the new company.

Some people set up a trust that leaves its voting right to the current owner and gives benefits of dividends to her children etc.

How you maneuver the valuation of the shares

Once you decide when to transfer the shares, you will have some options to lower its share price such as:

  • Retirement pay
  • Realize losses by writing off non-performing assets

The point is to book as much as losses possible to lower the corporate income to lower the valuation. The valuation depends on its income, dividends, and its net assets (marked to market). I will write it more in details later in this blog.

I would like to provide a free consultation in a brief form as to how much the shares of your company is and how to reduce the cost of the transfer. There should be several options to transfer the ownership.