Five Reasons Owners Actually Do Sell Their Companies to Their Key Employees (Part 2 of 3)

In the previous issue of The Exit Planning Navigator®, we surveyed the seven reasons business owners want to sell their companies to their key employees. As you know, motives are very different from outcomes. In this second part of the series, we discuss the five reasons that owners actually do sell their companies to their key employees.

1. 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 so is because their own financial independence is secure.
2. 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.
3. Owner has sufficient time to execute this transfer. 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 (or at least in control of) the company for at least five to ten 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.
4. Low Business Value. 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 must tell the KEG what that amount is. The KEG then knows 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 owner. "Excess" in the sense that it is 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 nonqualified deferred compensation plan that pays the owner after the owner has left the company.
5. A planned sale to a KEG is faster and less risky. 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 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 then, 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. The advisor who sent you this newsletter can help you to decide if a transfer to key employees is the best exit option for you.

The next issue of The Exit Planning Navigator®, will conclude our discussion of selling to key employees. Having already looked at why owners want to sell to key employees (Issue 68) and why they actually do sell to key employees (this issue), we will look at the reasons owners decide not to sell to their key employees.

Subsequent issues of The Exit Planning Navigator® discuss all aspects of Exit Planning.