Question:
One of my clients is a married couple, in their mid-50s, who own a very small consulting engineering business (S-corp).  The wife owns 60% of the business, and the husband owns 40% of the business.  They only have two employees, both of whom are engineers.  At this time, the employees have no ownership in the business.

My clients would like to figure out a business succession plan so that one or both of their employees could take over (buy) the business when they retire in 10 or 15 years.  They are willing to begin selling stock in the business to their employees now if necessary.  The only problem is that the employees are not high-income, and may not be interested in reducing their salary for shares in the business.

Answer:   Very simple. Determine the amount of Life Insurance required         to "fund" the buy-out, and then INCREASE  the income of each         employee by that amount. However, you do NOT give them         the increase, instead, it is paid to the Insurance Company. The         net effect is that each employee OWNS the policy, and the only         "cost" to him is the amount of the Income Tax on the increase !

My clients would like to figure out a business succession plan so that -one or both of their employees could take over (buy) the business when -they retire in 10 or 15 years.  They are willing to begin selling -stock in the business to their employees now if necessary.  The only -problem is that the employees are not high-income, and may not be -interested in reducing their salary for shares in the business. Well, the last part doesn't sound good since it sounds like the employees are only interested in taking over the business if they get it for free.  That raises a more fundamental question, and one that's harder to get a truthful answer to--do those employees really *WANT* to own and operate a business?  Some people simply are not able to deal with the uncertainties involved with owning their own business--like the little fact that whether or not they get a paycheck depends entirely on whether or not they can put cash in the bank.

It's difficult to get a straight answer to that question because, if asked, you will tend to get the answer they believe they are supposed to give (which will be "yes").

Someone who truly wants to run the business would generally be willing to pay for it, because they happen to believe they would be so much better at running it that they'd be able to pay off the note *AND* still make tons more money.  Of course, if they really believe that and the barriers to entry aren't great, they could just go hang out their own shingle.

Additionally, you have to critically look at what value there is in the operating business--do the current owners really have anything that *can* be transferred to a new ownership?  If the goodwill attaches too tightly to the individuals, there may not be much there that could be sold.

Finally, what is the reason the current owner has for wanting to transfer the business?  After all, if the employees don't want to pay for it, it doesn't appear to make a lot of *economic* sense to transfer it to them as opposed to simply closing the door or looking for an outside buyer.  Is this perhaps the issue of just wanting the ego boost of having created a "successful" business that will last beyond their involvement?

My own take is that these types of transfers can work--but only if both sides are motivated to enter into the transaction (neither one is doing it only because they feel they "have" to do it) and there is a true negotiation where each side gives and takes.  What I'm hearing right now in your post is that this is a project being pushed by the current owner and there doesn't appear to be any "buy-in" (literally or figuratively) by the employees.

My clients would like to figure out a business succession plan so that - one or both of their employees could take over (buy) the business when - they retire in 10 or 15 years.  They are willing to begin selling - stock in the business to their employees now if necessary.  The only - problem is that the employees are not high-income, and may not be - interested in reducing their salary for shares in the business.

That's a complicated question, and no doubt you'll talk to an attorney specialized in the area - that's necessary because all of the options and potential traps. Especially on the tax side of things there can be some disastrous unintended consequences, particularly for a sub-s (tax bills but no cash to pay them, disqualified status from creating another class of stock, valuation issues for stock given in lieu of compensation, large gain realizations, etc etc).

The goal of the plan, unless there are some loyalties or other issues involved, is to maximize the sale price of the firm. Is selling to the employees the best way to accomplish that? Assumedly your clients built the business over many years and are key employees in the company, which raises valuation questions once they exit the firm (will it have any remaining value?). If they can sell or merge the firm into another business well before the 10-15 years are up, with a promise to stay on for some time period, they might extract a higher purchase price than through a sale to the two employees. If they want to protect their employees' job security, well that could be part of the deal too. So maybe that's what they plan around, the goal of sprucing up the shop to make it most attractive to a potential buyer.

Another issue: would the two remaining employees be successful running the firm without your clients still involved? Aside from the bummer of seeing your baby go down the tubes, this is a major consideration if the purchase will be financed by future cash flows from the business. If they're uncertain about their ability to run the business, then they probably want to get someone else involved in the purchase like, the employees get part of the company, and the replacements for your clients buy the rest. Or, again, they just sell to another firm that absorbs the employees and your clients' client base (which may be its biggest or even only et).

I wish I could point you to a good book on the topic, but I don't know of one hitting on all of it - again, it's a pretty complicated topic that involves a bunch of legal questions as well as practical business questions. Best advice is to hire an attorney practicing in the area, or a firm that does a lot of succession planning - not necessarily a law firm, but certainly one able to advise you on all the different purchase scenarios.