Ownership transition is a natural part of the business lifecycle for many companies. Consider that some U.S. companies in operation today have been in business for centuries. Worldwide, you can find businesses that have been going strong for more than a thousand years.
You, on the other hand, are a human, with a limited life expectancy and perhaps a plan to retire. That means diversifying your wealth and maybe working less.
If the business you’ve built is going strong, an outside buyer could bring upheaval. What could happen to the key employees who helped the company succeed?
In fact, those employees might be the best prospects to lead the business next. They know your customers better than anyone else. They understand your industry. They clearly care about the continued success of the company.
But you might also worry about straining those relationships with sale negotiations. And it’s unlikely they have the capital needed. So, what can you do?
Why Employees Can Make Great Business Successors
A capable business leader can tell when employees are interested in, and successful at, increasing profitability and growing company value as a team. Employees who have demonstrated their commitment and capability can help provide stability in a transition and uphold the company culture you’ve worked hard to establish.
Your employees have already had years of experience, training, and maybe even practice. If your business is highly specific or in a niche industry, this can be especially important. If you’re fortunate enough to have been able to schedule vacation time away from work — and leave it all in their hands — you’ve seen how they handle the critical thinking and creative problem solving running a business can require.
Plus, proven leadership doesn’t need to be “sold” to the rest of the team or your customers like an outside third party might. Employees whom you’ve trusted for years (or decades) are likely to see ownership as a reward for a career’s worth of loyalty and dedication, and they’re less likely to pull up stakes and relocate, potentially leaving your community and local economy with a major-employer-shaped hole.
Selling to Employees Can Have Its Own Challenges
Let’s say you’ve built the dream team and have full confidence in every aspect of their ability to run the business. What could possibly go wrong?
Financing the Deal
It’s unlikely that any one employee has the funds needed to purchase the company outright. Even selling to a team of key management employees is likely to require financing. That can mean a business lender, seller notes, private equity, or some combination of financing options. If their credit history is less stellar than their work performance, lenders could be challenging to work with.
Private equity can lead to giving up too much control. Seller notes might sound good, but that means carrying the risk without being able to help steer the ship once the sale is final.
Another common financing tactic is to pay out significant employees bonuses that they in turn use to buy the business. But that’s often not the most tax-efficient approach, and it limits the benefit of ownership to the select few employees who receive these bonuses.
Risk
Seller financing, whether for part or all of the purchase price, involves risk. But a direct sale to employees introduces a level of financial risk to them as the new business owners that they may not be prepared for. It’s worth investigating options that can confer some of the same benefits of ownership on employees without requiring them to shoulder ownership risk.
Negotiating the Sale Price
An independent business valuation is a smart early step if you’re exploring a business sale. In fact, it can be motivating when a business valuation comes in higher than anticipated. But negotiating a selling price is about more than valuation — it’s about what buyers are willing to pay, and inside employees can sometimes have a deflated view of a company’s actual value. And without competition, there’s little motivation to consider a higher price.
Preserving Important Relationships & Moving On
What if you want to end your ownership role but not your leadership career? As retirement nears, it’s smart financial planning to diversify. Stepping away from ownership can also help free up time as successors start taking on more responsibility: shorter days, fewer weekends, and longer vacations can all become a reality. But if you’re not ready to move on entirely, jumping into a sale process could send you toward the door before you’re really ready.
At the same time, your dream team of leaders could need intensive coaching through the transition into ownership. Or fresh conflicts could surface that threaten continuity and cohesion.
ESOP: How to Be an Employee of Your Own Business
For business owners ready to step back from ownership, but who aren’t totally sold on the idea of selling for any of the reasons outlined above, an employee stock ownership plan deserves a close look. Here are four key reasons:
Control. When you sell to an ESOP, you control the timing — and your exit. Want to stay on three more years to oversee the succession plan? How about 10 years? As chairman of the board and a leadership employee of the ESOP-owned company, you have the choice.
An ESOP also gives you the choice over whether to sell 100% ownership of the company, or a smaller percentage. You can even create a plan for a partial sale in the near future, and sell another portion down the road.
Liquidity. Like other business sales, ESOPs can be financed in a variety of ways (and in a wide range of combinations). But you don’t need to wait for years to get significant liquidity to diversify your assets.
Employee ownership. An ESOP creates a way to reward employees through beneficial ownership of the company. While the ESOP trust becomes the legal and financial owner, employee owners earn annual share allocations, and on their termination of employment, they become eligible to receive distribution payments as their shares are repurchased.
And if you choose to stay on as an employee, you can earn your own fresh ownership stake in the company, too.
There’s a lot more to learn about the benefits of an ESOP for selling business owners, employees, companies, and the communities they call home — including significant tax advantages for ESOP-owned companies. Did you know, for example, that a 100% ESOP-owned S corporation has no federal income tax liability?
Start learning how an ESOP compares with the other most popular business exit plans when you download our free Ultimate Guide to Business Exit Strategies. Click below to get your copy today.
