How To Sell Your Business to Employees
As an entrepreneur and small business owner, you may have reached a point where you are ready to retire or move on to another venture. As you navigate your exit strategy, one of the best options to consider is selling your business to your employees. Employee buyouts allow business owners to exit their companies with a sense of accomplishment and satisfaction, knowing that the company will be in the hands of their trusted employees.
This article will provide a primer on how to sell your small business to employees. We will cover the various deal structures, financing options for both the buyer and seller, and some of the special considerations you should examine when planning the sale.
Introduction to Employee Buyouts
Before dissecting the process of selling a business to employees, it’s essential to define an employee buyout. An employee buyout (EBO) is a transaction where the employees purchase a business from its owner. This type of sale allows business owners to realize a financial return on their investments while transferring ownership of the company to their trusted employees.
There are several benefits to selling a business to employees. Most importantly, the transition is typically smoother when the new owners already know the company, its culture, and its customers.
One consideration sellers should keep in mind is that EBOs typically result in a lower business valuation than expected if the company was sold on the open market. In an open market environment, several third-party buyers may compete for the deal, which drives up the purchase price.
Types of Deal Structures
When structuring an employee buyout, there are several options. The most common are leveraged management buyouts (LMBOs), employee stock ownership plans (ESOPs), and modified buyouts. There are also several forms of financing for employees looking to purchase the company.
The best structure for an employee buyout of your small business will depend on various factors, including the company’s size, the number of employees involved, and the financial resources available.
Leveraged Management Buyout
A leveraged management buyout is when a group of employees, typically key employees and members of the management team, purchase the company with the help of outside financing. This financing typically comes from banks and other conventional lenders, though management may turn to private equity funds if a bank is unwilling to lend for a buyout. Private equity funds can provide capital in exchange for a share of the company and loan to management.
The benefit of this structure is that it allows the employees to purchase the company with a smaller upfront investment. The downside is that the employees will have a large amount of debt to pay off, which could impact their ability to run the company effectively, particularly if there are significant debt covenants placed on the business or if interest rates are unfavorable.
Employee Stock Ownership Plan
An employee stock ownership plan is typically a retirement plan that allows employees to purchase shares in the company. This structure has several benefits for both the seller and the employees. For the seller, it provides a way to sell the company, while maintaining some control over the company’s future. For the employees, it is a way to become owners in the company over time, which can increase motivation and job satisfaction.
The main disadvantage of this structure is that it requires a significant amount of paperwork and administrative effort. In addition, the employees will need to purchase the shares, which could be a barrier depending on their cash flow.
Modified Buyout
A modified buyout is a combination of LMBO and ESOP. In this structure, the employees purchase a portion of the company’s shares over the first few years, and the rest of the business can be sold later.
While the structure can vary greatly, typically sellers will create an option pool for employees to purchase shares over time. Once all of the shares have been purchased, which may take several years, the seller can decide whether to sell the rest of the business to the employees or to another party. Given the long time horizon, a modified buyout requires several years of continued seller involvement.
Closing the Deal
Once all parties involved in an EBO have secured terms and financing, it’s time to finalize the business sale. Depending on the transaction’s structure, this may involve the transfer of ownership and/or assets from seller to buyer.
If installment payments are involved, then it’s vital for both the buyer and seller to have detailed documents clearly outlining terms such as the sale price, amount due upon closing, payment schedule, and any late fees or penalties associated with delinquent payments.
Once all documents have been signed and funds are exchanged, it’s time for all parties involved to finalize the sale process by filing the necessary paperwork with state and federal agencies, such as the Internal Revenue Service (IRS).
Remember: Preparation is Key
Selling your business to employees can be beneficial both financially and emotionally since it allows you to do your due diligence and realize a financial return on your investment while also entrusting your company’s future with those who know it best: your employees.
To ensure a successful exit plan and transition when selling your business to employees, thoroughly prepare it for sale by hiring professional advisors when necessary, understand tax implications associated with the sale of your company, and finalize all required paperwork before closing the deal.
With these tips in mind, you can ensure that you get a fair price and peace of mind when selling your business.