Selling Your Business to Your Employees…

The following excerpt is from Mark J. Kohler and Randall A. Luebke’s book The Business Owner’s Guide to Financial Freedom. Buy it now from Amazon | Barnes & Noble | iTunes | IndieBound

It’s actually not that common of a situation for a business owner to sell to an employee or employees for three major reasons. First, employees typically don’t have the capital to complete the purchase, even if they know the inner workings of the company and could do a good job running the business.

Second, an employee may not think the business is worth as much as you do because they’re privy to the inner workings and dysfunctional aspects of the business.

Third, it’s generally not a good idea to start approaching your employees and telling them you’re interested in selling. Employees tend to get a little concerned because they see a situation where they may not have a job if you can’t find a buyer, and they tend to start looking for other employment.

However, in those unique situations where you can approach one or more of your employees who want to buy your business or who have expressed an interest in doing so, you can often be in the driver’s seat regarding price and terms. In fact, an employee may have an insight into the future value of the business and passion to carry it on. Thus, you may be able to get the price you want, set up a promissory note and have the security and collateral to come back in and take over the business if you have to for lack of payments by the employee/buyer.

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For example, in a situation where the employees are buying, there will typically be a Note, paid by the profits of the company and the stock of the company securing it. The owner will get regular reports regarding the financials, and if sales or profits start to go south, the owner can take back control of the company to rein things back in. This is a typical provision and fair to the owner in order to protect the company, which is essentially the asset paying off the Note.

A suggestion we make to business owners in this situation where the owner has already established a strong relationship with one or more employees is to take their time in the process with the transition of ownership and leadership.

First, start with training and leadership. Make sure the employees who think they can buy the business can handle it once they have the reins. Consider signing an agreement that starts the process and then give them more important roles, not necessarily with extra compensation, but with the written promise that ownership will be transferred as they prove themselves. This proving period could be for showing things like maintaining profit levels and production quotas, maintaining morale with key employees or simply showing leadership skills with good decisions when the owner steps back a little from operations.

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Next, consider appointing the potential employee/buyer an officer of the company or adding them to the board of directors or management team. You still control the process and the positions as the owner/shareholder/member, but they get a little rope to either win your approval or that of the other employees — or hang themselves in the process.

As the process evolves and the employee or employees show they have what it takes, you’ll then be duty-bound to start transferring ownership of the company; however, there can still be strings attached. This is called a “vesting phase” under what is known as a “vesting schedule,” where real equity ownership and voting rights will transfer to the employee only under certain conditions and over a certain period. In turn, the purchase and sale are executed as stock transfers and the employees start to pay off the Note with the profits they’re receiving and getting taxed on during the transition.

Finally, some owners choose to begin transferring a majority of the equity ownership through nonvoting stock or similar types of ownership interest, which allows the owner to maintain control through owning a majority of the voting interest while selling the equity or profit interest that’s funding the buyout. Don’t be afraid to be creative and demand protection for yourself during the transition.

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Let me tell you now, because someone else may not be in the position or have the guts to tell you, letting your company go to an employee — due to the close relationship or friendship — isn’t easy. You’re going to want to step in and be the hero at times and will want to stay emotionally attached to the company, customers and employees. Don’t do it!! Be strong, and let the transition take place. I guarantee you won’t like certain ways they’re running the company.

It doesn’t matter what their style or approach to the company is as long as they’re making a profit and are financially successful! Keep your eye on the ball. You sold the business so you could have more financial freedom, flexibility and/or retirement — you didn’t sell the business to leave a legacy in the community or neighborhood. Let the business evolve and the new owners move onward and upward. As you get quarterly reports and if you notice that the new owners are starting to drive the business into the ground, you can jump in — but only then. Otherwise, you’ll undermine the buyers and potentially blow up the whole deal. Stay out! Watch from the sidelines. Cash your checks and go on a cruise or something.