Why Owners Actually Sell Their Companies to Employees
The next in a series about selling your company.
In the first article you learned why business owners want to sell their companies to their key employees. But motives can be very different from outcomes.
In this second article, I will discuss five key reasons why owners actually do sell their companies to their employees.
- • The owner has already achieved financial security.
Owners who have already achieved financial security — separate from and prior to any sale or transfer of their companies ― enjoy the luxury of selling to their key employees.
They may have wanted to sell to them because they felt they “owed” their employees or even because they had promised to do so, but the reason they actually do sell to their employees is because their own financial independence is secure.
- The owner has no alternative.
With few exceptions, owners whose companies are worth less than $2 million (and who do not have children who can assume ownership) sell to key employees because they have no other option. These owners do not consider liquidation to be a viable option.
Business owners who need full value from the sale of their companies to secure financial independence sell to key employees when they have left themselves sufficient time to orchestrate that type of transfer.
Typically, an owner must stay active in the company, or at least in control of it, for at least five to 10 years after the sale process begins in order to attain financial security. Owners in this position have (usually at the prompting of and with the help of their advisors) taken steps to position their companies for a sale to key employees.
First, they have hired and groomed employees who not only want to be owners but also have the ability to assume ownership. Because they have this ability, owners have made themselves dispensable to the success of their companies. Their companies can flourish without them.
In addition, these owners have made sure that their businesses are adequately capitalized with little debt so that cash flow can be paid to them, rather than to meet ongoing capitalization requirements and debt repayment.
Often, the value of the business is not only less than the amount the owner needs to achieve financial independence; the value is unlikely to ever be high enough to be sold to an outside buyer.
For owners in this situation, the solution is a gradual sale to the management team. This type of sale allows the owner to continue to work and receive compensation, yet it also holds out to the key employee group (KEG) the promise of eventual ownership.
Owners first determine the amount of cash they need to achieve financial independence and then must tell the KEG that amount so the KEG will know the amount of cash flow that it must pay the owner through the transition period.
The owner’s established amount is a combination of purchase price and “excess compensation” paid to the owner — “excess” being money the owner can save and invest. Often this takes the form of increased retirement plan contributions. Or, it can be in the form of a non-qualified deferred compensation plan that pays the owner after the owner has left the company.
Owners whose companies exceed the $2 million threshold choose a management buy-out because, by design, their employees already own a significant portion of the company and they are able to exit with more money in less time.
In the first part of the two-part sale to management (discussed in John Brown’s book, “The Completely Revised How To Run Your Business So You Can Leave It In Style”), an owner sells a minority interest in the company to a group of key employees. Before the second phase begins, the owner has been paid for the minority interest and the company ― under the operational control, in large part, of the key employees — has demonstrated an ability to generate enough cash flow to fund the owner’s buy-out via conventional bank financing.
In the second phase, the company funds the balance of the buy-out through a combination of debt and equity.
If you are considering a sale to key employees, you must work with advisors skilled in designing this type of transfer. You must also allow adequate time to complete the transfer.
To read why owners say they want to sell their companies to key employees, the first article in the series, click here.
Ken Stiefler is president of eXITS, LLC and Stiefler Financial Solutions in Denver and has worked with business owners for more than 21 years to help them achieve their financial and succession objectives. Stiefler is an affiliate member of the Business Enterprise Institute Network of Exit Planning Advisors and the Home Builders Association of Metro Denver. For more information, call Stiefler at 303-695-6994, or visit his web site at www.kasfinancialsolutions.com.
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