Seller's Employment Contracts

When an employment contract is used in a business sale, the seller becomes an employee of the new owner. This is generally a short-term solution. Few entrepreneurs can successfully make the adjustment to taking orders as an employee once they've gotten used to calling all the shots in the business they used to own. Generally, the relationship sours and the seller leaves within a year to 18 months, sometimes causing the entire deal to unravel in the process.

One reason why you may want to agree to an employment contract is that it is virtually the only way you can continue to receive perks such as insurance, an expense account, a company car, travel to seminars and conventions in Hawaii, etc. Salary and benefit payments to or for you are deductible business expenses (under the usual rules) for the new owner of the company, and taxed as ordinary income, subject to payroll taxes, to you.

Employment contracts are frequently used in family businesses as part of a succession plan. Where the older-generation founder really does intend to stick around for a while, and the younger-generation new owner can deal with any ego problems and make good use of the founder's advice, experience, and skills, such arrangements can make good economic sense.

Just be careful that you are really functioning as an employee, to satisfy the IRS. If you do too little for your pay, the payments won't be deductible; if you continue to do everything you used to do as owner, the entire sales or succession transaction can be treated as a sham by the IRS, bringing you an endless number of tax problems.

If you do use an employment contract, make sure that it's separate from the business purchase agreement so that if the employment relationship falls apart, the entire deal won't collapse.