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.
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.
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.
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.