Should You Sell Your Business to Employees?

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Perhaps your employees would make the best next owners of the business. How do make that happen?

“I just work here.” This can sum up the perspective of an average employee who does not own stock or have any real ownership in an organization. There’s no tangible investment. Many individuals go to work to earn a paycheck, and a lack of engagement is reflected in attitude, morale, and productivity.

As a business owner, you may be looking for ways to change this value proposition for your top employees. Or you may want to earmark a specific internal successor or successors to sell the company to—and provide the means to do it—giving you options when it comes time to cash out.

Doing all of this has reciprocal benefits because it can also increase the value of the business. And sometimes, the best buyer for your company is your own employees.

Succession planning

Do you have an exit plan? It’s a question we ask all of our clients. Succession planning can be a complex process, something you shouldn’t only attempt to put in place when you are ready to step away from your business.

Business succession planning is a process of financial and logistical decisions about who will take over the organization. One of the biggest decisions is whether you will sell the business to an outside individual or organization, or to turn management and ownership over to members within your company, and potentially sell to them directly.

When to sell to an employee—and the advantages of doing so

The asking price of your business could likely exceed the capability of any employee to afford its purchase. You also may conclude that you have no employees capable or willing to succeed you as the business owner. These are signs that it might be wise to explore selling to an outside third party, or to start setting up mechanisms for them to afford the purchase (these will soon be explained under “Sticker shock”).

With planning and a commitment to building the value that your employees contribute to the company, a succession plan that sells the company internally can be your best choice—especially because of the lucrative tax benefits it offers.

Selling to your employees also provides peace of mind by providing business continuity. If you built an organization, you’ll probably care about what happens to it even after you no longer own it. Turning ownership over to workers who understand and contribute to the company culture provides assurance that it will continue to operate as intended.

There’s also the advantage of familiarity. Employees already know the details and value propositions of what they’re buying. It doesn’t obviate proper due diligence on anyone’s part. But as an owner, you will spend far less time identifying and attempting to sell your company internally than you would to prospects.

Sticker shock

Selling your business to employees may not be possible, though, as they often don’t have the means to purchase the company. You might opt to lower the price or otherwise offer concessions that make it affordable for them—but is this in your best interest?

A better choice is to help fund the sale of your business to your team through an Employee Stock Ownership Plan (ESOP). An ESOP paves the way to company ownership by allowing employees to own stock in your company without having to purchase shares.

After an ESOP is implemented, employees receive an ownership stake in the business as a part of their compensation. These shares are held in trust. They cannot be used while employed but must be liquidated if an employee leaves the company.

As a business owner, you have the option to use an ESOP as a way to fund the sale of your company to employees. The employees can use its value to buy your shares. This can happen as an immediate purchase if the ESOP has been in place for an extended period of time. Or, the ESOP can be funded through commercial loan financing.

In many cases, the sale of a company using an ESOP is not immediate. As the company owner, you finance the sale. The ESOP purchases your ownership and offers you a note that yields an attractive interest rate. Your employees now own the company, and you receive the sale price plus interest over time.

Some owners also opt for setting up and funding a dedicated ownership fund that—and this is also applicable to shares in an ESOP—an employee can use as collateral for an outside loan from the bank.

More options

Depending on the transaction’s structure, it can also offer tax advantages such as capital gains deferral. Selling your company to employees with an ESOP is just one of the ways you can plan a successful exit and maintain business continuity.

In many cases, you end up being the “bank” that finances the transaction. Do you have employees with access to capital but not enough for an outright purchase? You can assist them with the outright purchase by cosigning a loan. You can also structure a staged buyout that allows your employees to purchase the business and still benefit from your presence.

We can help you with expert advice on succession planning and exit strategies.

How to Prepare Employees for a Management Transition

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For smooth sailing, keep your team educated, informed, and included

Humans don’t tend to like change unless they can clearly see a benefit from it. It’s hard-wired into everyone to trust things, people, and methods that have been around for some time, and to be wary of any element which disrupts the status quo—and business is no exception. New faces in management will have to earn the trust of their team, build new relationships, and probably make and weather the consequences of a few unpopular decisions.

There are four major maneuvers in orchestrating a professional power shift. When they’re used in the management transition process, they demonstrate personal care for your employees and help smooth any bumps in the road.

1. Understand how organizational change affects employees

The first step is to see things from your team’s perspective by understanding the deeply rooted effects of change. The American Psychological Association (APA) 2017 Work and Well-Being study showed that half of all employees were negatively impacted by recent, current, or anticipated change.

Impacted how? Distrust, cynicism, decreased confidence, and skepticism took hold of many individuals who didn’t believe management was telling them the whole story.

Worse still, fewer than half of employees had any trust that changes made by management would be beneficial to staff. The APA study also highlights how to change negatively affected employee health and the quality of personal lives, plus created a feeling of job insecurity. This mix leads to resentment and disengagement, the latter of which can kill companies.

The good news is the killer can be killed by empathizing with employees during change and engaging in positive communication with your team.

2.  Timing the announcement well is crucial

Discretion is the better part of successful communication during a transition. Letting employees know from the very outset (when many details have yet to be finalized) may seem like the right thing to do, but it can only add to unease in the absence of facts.

Hold off on letting employees know until the shift is set in stone. This provides the ability to solidly answer any question and avoid the dreaded “We don’t know.” Communication after finalization may not hold good news for every employee, but at least they’ll know where they stand and can make grounded decisions from there.

3.  Include your whole team in the new vision

It’s clear that being transparent and receptive during an organizational change fosters trust among employees, and that’s a major deciding factor in not just the success of the shift but the business itself.

Last year’s APA report (page 7) highlights how nine out of 10 employees who feel they can trust their employer are motivated to do their very best at work. Compare this to the data that shows a lack of trust greatly increases employee stress and tension as well as causing a high proportion of staff to leave that company within a year.

A transition is a great time to elicit feedback from employees and to emphasize the pros while acknowledging the cons. As a manager, be prepared to explain why change is necessary and give everyone a safe platform to air the legitimate views, ideas, and concerns which can be productively addressed.

Keep employees in the loop regularly as the new normal is implemented, even if things stumble along the way. Silence creates a sense of exclusion and quickly becomes another form of stress.

4.  Provide education, training, and tangible benefits

Two common employee fears during a management transition are coping with a change in their assigned role/responsibilities and the potential for an increased workload.

Again, humans resist change unless it’s demonstrably in their best interests. Provide educational resources and training in new processes. These may seem like they have the potential to cause new stress but managers should reassure employees that this information translates directly into increased value and new skills.

Ideally, an increased skill set makes a business more competitive and makes its employees a more desirable commodity, now and in the future. It shouldn’t be a hard sell, either—94% of employees say they’re willing to stay with an employer if they help them to learn new things. Change presents the opportunity to offer workers fresh challenges and new ways to progress.

Beyond those benefits, a company may see change as the right time to introduce well-implemented employee incentives and rewards. This approach works in two ways: It shows that a company values their team during a difficult time and reinforces loyalty in a period where many employees may be heading for the door.

These four steps are the bedrock of effective employee preparation for a management transition. For in-depth guidance on planning a successful transition and additional strategic business advice, reach out to Provident below.

Provident CPA & Business Advisors helps successful professionals, entrepreneurs, and investors get more out of their business and work less. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning and business strategy and discover how we help businesses exceed expectations.

Increasing the Value of Your Business With The Value Builder System (VBS)

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Knowing the eight drivers that determine a business’s value is the first step to knowing what your company is worth

Different business owners are, well, different. They practice different leadership styles, sell different products, and employ different strategies. They all have one thing in common, however: they want to increase the value of their businesses.

And whether you plan on exiting your business in the near future or staying on for a while longer, increasing its value through concerted, concrete steps must be a priority.

What is your business worth?

It’s a straightforward question, but one that puzzles many business owners. After all, every company is unique, which often makes the art of valuing a business something of a “subjective science.” Certain factors are based on the business itself—such as the net value of its assets, for example—while others are the result of outside circumstances, like the sales of comparable businesses within the same industry.

In most cases, businesses are valued as net profit times multiple. The multiple is applied to a specific financial metric of a company to calculate its valuation. The most common financial metrics that multiples are applied to are:

  • EBITDA, or earnings before interest, tax, depreciation, and amortization
  • EBIT, or earnings before interest and taxes
  • Net earnings, or earnings minus the cost of goods sold, taxes, and expenses during a period of time
  • Revenue, or the earnings a company receives during a period of time

Put simply, the multiple is as a measurement of risk—the higher the multiple, the less risky the investment for a buyer. To increase the value of their business, owners must do one of two things: increase profit or increase the multiple.

The VBS: an introduction

Business valuation professionals use a variety of methods to help owners determine what their business is worth and increase its value. One of the most comprehensive and highly regarded methods is The Value Builder System or The VBS. The brainchild of John Warrillow, author of the best-selling book of Built to Sell: Creating a Business That Can Thrive Without You, The VBS is a statistically proven methodology for increasing the value of a company through increasing the multiple.

The VBS differentiates itself from other methodologies based on 8 factors, or “drivers:”

Financial Performance

This is the most straightforward driver, but it’s also one of the most difficult to deliver. It’s made up of your top-line revenue and your bottom-line profit, but there are other elements to consider as well. Have you invested in an audit? If a buyer were to scrutinize your numbers, do they add up?

Growth Potential

Many business owners view their business based on its past successes, but a buyer will typically focus on its potential. What does the future hold? Can this business operate in a different market if needed? Can you cross-sell additional products or services to existing customers? These are all questions that determine a business’s growth potential.

Switzerland Structure

A successful business is an independent one. It doesn’t rely on a particular customer, employee, or supplier in order to operate efficiently or effectively. Some questions to consider: Do you have diversification among your customers and suppliers? Are you overly reliant on a single employee? If not, your business is a risky investment for potential buyers.

Valuation Teeter Totter

The more cash your company needs to operate, the less likely a buyer is willing to pay for it. In other words, your business needs to be generating cash. Can you collect receivables faster? Can you extend your payables? Doing so will help you improve your Value Builder Score.

Recurring Revenue

Have you considered how your business will continue once you leave? Even if you don’t plan on exiting any time soon, this is an important factor in your business’s value. There are six main ways to create recurring revenue. In order from least valuable to most valuable, they are consumables, sunk money consumables, subscriptions, sunk money subscriptions, auto-renewal subscriptions, and contract revenue.

Can you move up this ladder? Can you channel your sunk money subscriptions into auto-renewal subscriptions, for example? If so, you can increase the stability of your recurring revenue.

Monopoly Control

When investing in a company, renowned investor Warren Buffet looks for the durability of a company’s competitive advantage or its “moat.” The wider the moat, the more leverage a company has. This leverage allows a company to control its pricing, which in turn creates more margin, better sales, marketing, and so on. Some questions businesses should consider: Does my marketing make my business different from my competition? And do my customers care? Is this a unique advantage likely to stay unique?

Customer Satisfaction

Happy customers are an obvious driver of a company’s value and success, but it can be difficult to gauge customer satisfaction in quantifiable terms.

Enter the Net Promoter Score (NPS). Your company’s NPS answers the question, How likely will my customers recommend me to their friends? The more data you have on this particular subject, the more you and your potential buyers will know that your customers are satisfied.

Hub & Spoke

Are you the “hub” of your business? If so, the likelihood of your business falling apart once you exit is high. In order for your company to succeed long after you leave, your customers, employees, and suppliers can’t be solely dependent on your contributions. One way to begin solving this problem is by documenting your processes so your employees will know how to operate when you’re not present.

Getting started with The VBS

These drivers come together to determine a business’s Value Builder Score. On average, companies with a Value Builder Score of 80 or above (The highest score is 100) receive offers that are 71 percent higher than the average business.

Now that you know which factors drive a healthy, successful, and high-value business, you can increase the value of your own company. The first step is to find out your business’s Value Builder Score, and an expert business advisor can help you determine this number—and figure out ways to improve it.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact on their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning and business strategy, and to find out how we can help your business exceed your expectations.

Exiting Your Business? Why You Need the Right Business Advisor

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Most business owners aren’t prepared to sell or leave their businesses, but the right business advisor can help fill in the gaps

So, you’ve decided to sell your business. Whether you’re planning to finally retire, start a brand-new venture, or pursue something else entirely, the decision to sell is arguably one of the biggest decisions you’ll ever make. As such, it requires a thoughtful exit strategy.

As you may have already realized, exiting your business is a multi-step process that requires careful planning. There are many moving parts to consider, including drawing up the paperwork, selecting the right successor, and selling your business tax-efficiently. You can go about it on your own, but working with a business advisor can smooth the process, provide needed direction, and give you the peace of mind that you’re making the most of your sale.

How an advisor can help you

If you’ve never worked with a business advisor, you might be wondering how they can help you. An advisor’s role can vary depending on the company’s growth stage and unique goals, but during the exit planning process, the advisor acts as the “quarterback” of your team. They help you make the tough calls as you determine when to make your exit and what the contingencies are if your initial plan doesn’t happen.

Here are a couple of specific ways an advisor can aid you before your exit:

Developing a continuity/succession plan. Many business owners plan on leaving their legacy to a qualified successor within their organization. This person might be a business partner, family member, or trusted team member.

According to a 2018 report, however, 58 percent of small business owners have no succession plan. An advisor can help you draft an exit strategy that addresses the buy/sell agreements of your business, as well as create a solid succession plan that covers how you will mentor your successor before you leave. Ironing out these details in a documented form will allow everyone involved in your company, including its pending owner, to have a clear understanding of their role in the transition.

Retirement preparation. Have you thought about how you will live once you exit your business? An advisor can help you plan for retirement by assessing your business’s finances and making personalized recommendations. The sooner you start working with an advisor, the more time you have to reach your exit funding goal.

What to look for in an advisor

If you’ve never worked with a business advisor, the thought of allowing someone you don’t know to help you coordinate such an important decision can be daunting. This hesitation is understandable, especially since there are plenty of “advisors” who don’t get into details nor always work in the best interests of their clients. Rather than guide them carefully through the process, they rush owners into making hasty—and sometimes regret-filled—decisions.

When choosing an advisor, consider the following factors.

Experience. You want to work with a business advisor that knows the ropes. Before committing to a partner, ask them about their experience with helping owners exit businesses. Have they helped owners pass their company on to the next generation? Have they worked with a business in your industry? These questions are all relevant to gauging an advisor’s experience and expertise.

A dedicated Team. While advisors have a wealth of knowledge to share, they might not be able to answer your every question. That’s why many business advisors work with a dedicated team of lawyers, financial advisors, and other professionals on a regular basis. By offering access to experts, advisors not only provide their clients with elevated service but further establish their own credibility.

Shared Values. Trust and transparency are key attributes of a successful advisor-client relationship. To ensure they will have a fruitful partnership, both parties must confirm that their values are aligned and they have the same goals in mind.

Making the most of your exit

A study from Massachusetts Mutual Life Insurance Company revealed that 70 percent of business owners think frequently or often about their business’s value. When it comes time to sell or pass on your business, you’ll want to ensure that you know what it is—and that this valuation is as high as possible.

Many advisors use the Value Builder System, a statistically proven methodology that helps businesses increase their values, to help their clients increase the value of their businesses. The brainchild of John Warrilow, author of Built to Sell: Creating a Business That Can Thrive Without You, the VBS is an ideal tool for company owners to take advantage of when attracting buyers.

Based on their Value Builder Score, the core of the system, companies can achieve a comprehensive assessment of their business’s “sellability.” From there, their advisors can help them make the necessary changes and improvements to move forward smartly.

Exiting your business can be a confusing and even overwhelming process. To make sure the transition is as seamless and lucrative as possible, the right advisor goes a long way.

Provident CPA & Business Advisors helps successful professionals, entrepreneurs, and investors get more out of their business and work less. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning as well as our business advisory services, and discover how we help businesses exceed expectations.