Seven Reasons Owners Want to Sell Their Companies to Key Employees (Part 1 of 3)

As a business owner familiar with Exit Planning, you know that you can leave your business in one of eight ways:

1. Transfer your company to a family member;
2. Sell the business to one or more key employees;
3. Sell to key employees using an ESOP;
4. Sell the business to one or more co-owners;
5. Sell to an outside third party;
6. Engage in an initial public offering;
7. Retain ownership and become a passive owner; or
8. Liquidate.

If you don't have a co-owner, a family member willing or able to succeed you, or your company is worth less than $2 million, your best option may be a sale to key employees. This article begins a three-part series that explains why owners want to sell to their employees (part one), what conditions often prompt an owner to sell to key employees (part two) and finally, what obstacles can prevent this type of transfer (part three).

Many advisors to business owners think a sale to key employees is a great option for companies that don't reach the "sale to third party" threshold. Typically, they define this threshold as the point at which a business can be sold for (largely) cash. While this may cause some owners to consider a sale to key employees, it is not the reason that most of them want to sell to key employees. Over the years, we've found that owners choose to transfer their companies to key employees for seven different reasons.

1. Some owners feel that they owe their employees something. They feel that their key employees have helped create the company and certainly have contributed to its success. These employees "deserve" the opportunity to purchase the business.
2. A variation on this "owe" idea is owners who want to provide their key employees the same opportunity they had to become financially successful.
3. Other owners choose this transfer because they have already promised their employees that they would sell to them. They feel committed to following through on this oft-times vague promise.
4. Some owners feel that the only way to continue their legacies, "do right" by their customers or carry on the culture that they have worked so hard to create is to transfer to their key employees.
5. Some owners are convinced (and some correctly so) that their companies are only valuable to the key employees who work there. With few exceptions, there is a market for companies worth more than $2 million. Historically, businesses worth less than $2 million (businesses with free cash flow of less than between $300,000 to $500,000) hold little attraction to outside third parties.
6. Maximizing their own income motivates some owners. They believe that key employees will pay more for their companies than any other type of buyer. This assumption, in turn, is based on another assumption that the business is not attractive to, or would be misunderstood by, outside buyers.
7. Lastly, some owners use the gradual sale of ownership interest to key employees as a way to motivate those employees to stay with the company.

No matter which of these is your reason to want to sell your business to key employees, it is prudent to investigate your motives thoroughly. For example, if you believe that your business (at a favorable valuation) is simply not attractive to outside buyers, I urge you to talk to others (particularly the advisor who sent you this newsletter) to test your hypothesis.

When owners want to transfer their businesses to key employees, do they actually do so? The next issue of The Exit Planning Navigator® discusses five reasons owners actually do transfer their companies. Until then, if you have any questions about this type of transfer, please contact the advisor who sent you this newsletter (kshort@claytoncapitalpartners.com).