How do you sell your business to employees?
Selling your business to key employees provides you with an alternative exit plan. There are several main deal structures that both buyer and seller can lean on to facilitate the transaction:
- Long-term installment sale
- Leveraged management buyout
- Employee Stock Ownership Plan (ESOP)
In this post, we’re going to explore the pros and cons of each strategy mentioned above.
Long-term Installment Sale
This is the orthodox way of transferring ownership to employees. The process begins with a business valuation to establish how much the company is worth. This is followed up by identifying the interested buyers/employees. Discussions as to the repayment period and how the deal will be financed are then entered upon.
- The installment sale is secured by the business’s assets
- Business continuity is guaranteed as new management are current employees
- Assurance of a steady payout for the seller over time
- You can negotiate to retain your salary and benefits throughout the transition
- Your remuneration as a seller is dependent on the company’s future success
- There are no big payouts at closing
- The management style of the buyer/employee might run the company aground
- Failure to close the deal with the employee can lead to a contentious work environment
- Full ownership transference can take years
Leveraged Management Buyout
One of the major stumbling blocks for employees keen to purchase a business is a lack of financing. With a leveraged management buyout, the buyer or seller can opt to bring on board a third party in the form of a private equity firm (PE), venture capitalist (VC), or conventional lender.
It’s worth noting that this type of deal structure works best when the business valuation is at least $5 million. The VC/PE will also want to see a competent management team and request that the company have a sizeable asset base to expedite debt financing before proceeding.
- Provides a quicker exit route for the seller (than a long-term installment sale)
- The seller receives a full and immediate cash payout
- VC/PE can provide future cash to stimulate business growth
- Employees are given an opportunity to grow their equity stake in the company over time
- This deal structure doesn’t work for every type of business
- The business is plunged into debt
- A third-party financer can introduce strenuous terms and conditions for both employees and seller
- Interested employees might not be welcoming of the initial minority stake offer wanting full control from the get-go
- Allowing employees to find the VC/PE introduces considerable risk as you don’t know what company information has been floated out to the public in their bid to secure funding
Employee Stock Ownership Plan (ESOP)
ESOP is one of the more defined techniques you can use to sell your business to employees. It’s especially useful if you plan on a gradual transition while you remain involved as the main owner.
ESOP is mostly a profit-sharing strategy that gives employees the opportunity to become part-owners. As the seller, you initiate tax-deferred contributions that are invested only into the business’ stock.
- ESOPs are great for sellers that are seeking the highest value and returns for their company
- ESOPs allow the business to be sold to many employees instead of a single interested employee
- Interested employees receive operating control of the company
- As a co-operative involving many employees, everyone works harder and is motivated to ensure business growth and success
- Seller receives a cash settlement at closing
- ESOPs come with tax-deductible benefits including being tax-free for buyers/participating employees
- It is difficult for a third party to purchase your seller’s stake in the company
- As the seller, you lose out on the initial funding money that you would have received in your payout
- An ESOP has financial responsibilities tied to it as well as a slew of administrative considerations
Deciding to sell your business to employees can be a rewarding way to exit the business. Knowing that you’re leaving the company to people who’re already familiar with the operations and who care for the business can give you the peace of mind needed to let go.
However, no business transaction is without its risks. That’s why if you’re thinking of selling you should consult with a seasoned M&A broker.
For businesses in Chicago looking for brokers, our team here at Sun Acquisitions is ready to help you map a way forward. Contact us today.
Looking for more insight on selling a business? Check out these links:
- Best Practices For A Successful First Meeting With A Business Owner
- Are You Financially Ready?
- Are You Emotionally Ready?
- Waiting Too Long to Sell
Disclaimer: Any information provided in this blog is not intended to replace legal, financial, or taxation advice given by qualified professionals.