Need to retire and cash out? Try this savvy move

DNY59 | E+ | Getty Images. Selling your business to your employees is a way to fund your nest egg — a deal that can be funded by a frequently overlooked SBA financing program.

For most entrepreneurs, their retirement nest egg is their business. They count on it to fund their golden years. Most founders dream of finding buyers who will ensure their legacy lives on and prospers. For some a good option is selling to employees.

Gene Broderick, 70, and his partner Duane Taylor, 72, learned this firsthand. When they decided to retire from their water-treatment business in Santa Rosa, California, by the first quarter of 2016, they needed to find buyers who could afford to purchase it. That was not going to be easy, given that Northcoast Waterworks brings in $2 million in annual revenue and their asking price was more than $1 million.

So they looked at selling the 10-person firm to a key employee.

Many companies look to sell to their workers either as individuals or in an employee stock ownership plan, which provides a company's workforce with ownership shares in the firm. Currently, there are 15 million participants in ESOPs and ESOP-like plans in the United States, according to the National Center for Employee Ownership, a nonprofit that studies the industry. Some well-known companies, such as Publix supermarkets and Quicktrip convenience stores, have created ESOPs.

But for smaller companies like Northcoast Waterworks, ESOPs aren't always practical. Employees may not want to own shares of a tiny firm because the investment is not as liquid as stock in a well-known company. Selling to them outside of an ESOP is usually very difficult because few can afford to buy out their employer. Unfortunately, employees are often the only potential buyers with the know-how to run a specialized business successfully.

As a result, many owners never find a buyer. They delay their retirement plans for years as they try to sell their business, then quietly close up shop without enjoying any financial rewards from the years of hard work they put in. Consider this: BizBuySell, a major marketplace for small businesses, currently lists more than 45,000 businesses for sale. Last year, when the number of listings was about the same, sellers on the site closed only 7,222 transactions.

What many owners don't know is that it is possible to sell to their employees — even those who have little savings — using financing backed by the U.S. Small Business Administration . As long as the employees have good credit and are not convicted felons, the SBA will let them purchase the business with little or no money down.

In fact, the SBA's 7(a) program, founded in 1953, incentivizes the agency to make loans for the acquisition of a small business by guaranteeing 75 percent of the loan that a bank makes to a borrower. The borrower has to put up 25 percent of the sale price, but it does not have to be the buyer's own money. It can be a loan from the owner or a gift from a family member. A loan from an owner has to be on standby for two years, in which the borrower cannot make any payments. After that, the term is usually another five to seven years.

This is what allowed Broderick and Taylor to sell Northcoast Waterworks last summer for $1.6 million. The buyers did not have to come up with the whole $1.6 million by themselves, because they had an SBA loan and financing from the sellers.

The buyers were Jarrad Fraser— Broderick's nephew and a technician who had worked for Northcoast Waterworks for 16 years — and Nick Bracesco, who owns a local well-inspection business that does pump work.

"We really wanted to find someone that was qualified," said Broderick. "The knowledgeable and skilled people we could have sold to were within the company."

In the transaction my firm arranged, the two new buyers put down 15 percent of the purchase price ($240,000), and the owners loaned them the remaining 10 percent ($160,000) to meet the 25 percent minimum required to get an SBA-backed 10-year term loan. Wells Fargo loaned them the remaining 75 percent ($1,200,000) in the SBA loan. If a bank wanted more evidence of the owners' confidence that they will be paid back, the buyers would put down 10 percent and the owner would lend them the remaining 15 percent.

What if the owners were not willing to lend them the money — and the employees had more cash to invest in the purchase? If they put down at least 25 percent ($400,000), the SBA would allow a bank to lend them the remaining 75 percent ($1.2 million).

That is still more manageable than getting a standard bank loan that is not backed by the SBA. With a traditional bank loan, the buyers would typically need to put 40 percent of the purchase price down, borrow 40 percent and get the owners to lend them the remaining 20 percent. Going that traditional route in this case would have meant the buyers had to put down $640,000, borrow $640,000 and get the owners to lend them $320,000. That would have been a lot harder for them to pull off.

The deal was a relief to the sellers, who wanted to continue the legacy they had built at the business. "We have several thousand customers that need their equipment serviced," said Broderick. "We didn't want to leave them in a situation where they wouldn't be able to get any kind of good service."

Why are banks interested in making loans like the one they offered to Fraser and Bracesco? According to Bonnie Jessen, a business development officer at Wells Fargo who closed the transaction, it's good business.

"We had very qualified buyers," said Jessen. "We had a business that had a long track record and good cash flow."

Fraser's experience in the business was a plus, too, she added. "Generally speaking, previous business ownership or a management background, preferably in a similar industry, is required," said Jessen. "When they have worked in a business and have the exact management background, that makes it all the easier."

So far, Fraser said running the business has not altered his day-to-day work very much, though his hours are longer. But it has changed his capacity to build wealth dramatically.

"In the back of my mind, I'm now not just getting a basic hourly wage," said Fraser. "I'm now reaping all of the rewards, all of the profits." That is an opportunity he would not have if he had not tapped the SBA loan program.

— By David Ryan, founder and managing member of Upton Financial Group, an advisory firm specializing in business value strategies and solutions

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