When it’s time to sell the business and retire or move onto something new, one option business owners may have is to sell the business to an employee. If there is an employee capable of owning the business and ready to do so, selling it to them could be a good decision and could be beneficial to the seller. However, it is important to note that there could be risks to doing this, so sellers will need to think carefully about what they want from the sale and whether selling to an employee will allow them to get what they need from the sale.

Company Retains the Culture and Values

The employee already knows everything about the business, and they likely already care about what happens to the company. They’re more likely to maintain the current culture within the company as well as stick to the company’s values. It’s also more likely they’ll retain the current employees, as they already have a connection with them and know how the employees work.  However, the Seller may want to think about whether selling to a single employee may ruffle the feathers of other employees?

More Control Over the Sale

When the buyer is an employee, the Seller often has more negotiating power and more control over the sale. They’ll be able to dictate more of the price and terms, and the buyer may be more willing to compromise since they’re already involved in the business.  However, when you only have one buyer, this can also lessen the bargaining power of the Seller, as well.

Less Hassle During the Sale

There is a lot that goes into preparing a business for sale, but some of this isn’t needed if the buyer is an employee. The employee is already familiar with the business, so there’s usually no need to produce marketing materials or try to convince them the business is worth purchasing. They already know it is. It’s still important to be transparent during the sales process, but a lot of this is easier with an employee instead of a buyer that’s not connected with the business.  Most sellers want to simply “hand over the keys” and this can be easier with an internal buyer, rather than an external buyer.

Smoother Transition to New Ownership

Since the employee already works for the company, the transfer of ownership is often a lot easier. The employees, customers, suppliers, and distributers most likely know the new owner, and there isn’t as much of a learning curve for handling the day-to-day operations of the business. This means the seller may not need to stay for consulting after the sale is completed.

There Can be Drawbacks

Of course, there are potential drawbacks or risks when selling to an employee. Some of these include the following.

• Lower Sale Price – Most sales to employees generate a lower sale price compared to sales to other buyers.  While this may seem counterintuitive, most internal buyers would think it would be less expensive to start a new business, than pay a market price for the Seller’s business.
• Lack of Capital – Most employees will not have the capital to purchase the business all at once or not have enough funds or credit for a bank loan. This could mean the seller must finance the sale, which can have drawbacks of its own.
• Employees May Quit – If the owner lets employees know they’re thinking about selling, the employees may wonder if they will still have a job. This may lead them to start looking for a new job and quit instead of waiting to see what happens.  This could also happen if there are any internal jealousies that result from a certain employee buying the business versus another.

How to Sell to an Employee

The most common way to sell a business to employees is through an ESOP or Employee Stock Ownership Plan. The employees in the ESOP are able to purchase stock in the business, sharing the ownership. Each employee receives an ownership stake, and the stocks are held in a trust until they leave the company. There are various ways to fund the ESOPs, including bank and seller financing. This can provide tax advantages like a deferral of capital gains taxes, which can be beneficial for the seller. Depending on how this is structure, the owner is still able to protect the company and can take control of the company again if needed to boost sales or profits.  An ESOP can be appropriate for businesses that make $1.5 million in cash flow or higher, as this can be an expensive option.  It’s also more appropriate for businesses with a strong, internal management team.  If you’re an Owner who wears many “hats”, this may not be the correct option for you.  If you are also concerned about getting all of the money up front and not having to worry about the business going forward, this may not be a great option for you.

Determining if Selling to an Employee is the Right Move

Selling the business to an employee or multiple employees may make a lot of sense if there is an employee ready and willing to take over the business. However, it’s not always the right move to make. Business owners will need to consider whether they need the sales proceeds upfront, whether they want to maintain the business as it is and help it continue to thrive in the future, or if they’re worried about what will happen if a new owner takes over the business. If the owner does decide to sell to an employee, they should start preparing for the transfer of ownership as soon as possible.

How to Prepare to Transfer Ownership

Before the business can be sold to an employee, there are some steps the owner should take. These steps help ensure the employee is ready to take over the business and that they’re going to be able to handle the ownership once they are in charge. The steps to take include the following.

• Training for Ownership – The training part of the transfer can be the most important. The employee learns more about how the business is run and is able to take more control over the business, but they do still report to the owner and will need to have some decisions overseen by the current owner of the company.  However, the longer the lead time, the better, especially if there are contingent payments, such as seller-financing involved.
• Higher Management Level – The employee can be moved up to a higher level in the company. The owner still has the control, but the employee has a little more free reign to make decisions for the business and learn more about how to run the business.
• Vesting Phase – During this, the ownership and voting rights start to transfer to the employee, and the Seller receives payments based on the agreement with the employee. The employee is now more in control over the business, and the Seller does less of the day-to-day operations.
• Final Control Transfer – At this point, the transfer of ownership is complete. The way this looks depends on how the sale is done, so it is possible for the seller to still have some say in the company and still receive profits to cover the purchase of the business. At this point, however, the employee is the owner of the company.

Selling a business to an employee can be a good idea, but it won’t work in all situations. If you’re considering selling your business and you’d like to sell to an employee, talk to your business broker or M&A professional, and legal professionals about what to expect and how it works. Visit businessbrokersaustin.com now to get help or more information on selling the business to an employee.