In case you haven't noticed, the business-for-sale marketplace is getting crowded. In 2015, the number of listed small businesses hit a six-year high on BizBuySell.com, due in part to the rush of baby boomers exiting their companies.
Given the volume of available businesses to today's buyers, selling to a trusted employee or a group of employees is becoming an attractive option for baby boomers and other sellers eager to achieve a smooth exit.
The Benefits of Selling to an Employee
Selling to an employee isn't an option for every business owner. Sometimes, healthy businesses simply don't have any employees who are willing or capable of taking the helm. In other cases, financial considerations and/or the seller's exit plans make an employee-based sale a no-go.
But under the right conditions, selling to an employee can provide several important benefits, especially when buyers have a lot of options in the marketplace like they have now.
- Business Continuity--As a responsible business owner, you care about what happens to your company after you're out of the picture. Next to a family member, a trusted employee is the person most likely to maintain the existing company culture and operate the company in a manner that is consistent with your values, and continue to employ team members who have come to feel like an extended family in most cases.
- Less Hassle--In a typical sale scenario, owners spend a lot of time selling prospective buyers on the virtues of their companies. Since employees are already familiar with your business, you won't have to invest time and energy in a charm offensive. Although you'll still need to adhere to sale fundamentals, an employee-based sale can mean less hassle than selling to an outsider.
- Smoother Transition--A sale to an employee often results in a smoother and faster transition for everyone involved because the company's staff, customers and vendors already know the new owner. Selling to an employee or multiple employees also allows you to make a clean break with the business rather than staying onboard for a period of time after the sale to provide extensive training and support.
Selling to an employee has some potential drawbacks. For example, it's not uncommon for employee-based deals to result in a lower sale price than the price that could be achieved if advertised in the open market.
Likewise, employees often lack the assets and capital to purchase companies outright. And that means sellers have to play an active role in helping their employee(s) fund or finance the transfer of ownership.
Using an ESOP to Fund a Sale to Employees
One common method for funding the sale of a small business to employees is through an Employee Stock Ownership Plan (ESOP). Rather than selling the business to a single employee, an ESOP enables you to transfer ownership of the business to all qualified employees.
ESOPs are usually treated as a workforce benefit. Employees receive an ownership stake in the business as part of their compensation, with shares that are held in trust until each employee leaves the company.
When an ESOP is used to fund a sale, the employees invests cash in the ESOP trust, which is then used to acquire the owner's shares in the business over time. In some cases, the ESOP can be funded through commercial financing, reducing the amount of time it takes for the seller to receive proceeds from the sale.
More commonly, ESOPs are funded through seller financing. Essentially, the ESOP acquires all of the owner's shares at once and pays the seller for the shares with a note that yields a healthy interest rate. Ownership of the company transfers to the employees and the seller receives the sale price plus interest.
As a seller, an ESOP can be a convenient way to achieve multiple sale goals, provided you can afford to finance a significant portion of the sale price. Also, an ESOP may provide important tax advantages (e.g., deferral of capital gains tax), depending on how the transaction is structured.
Is Selling to an Employee the Right Move for You?
Selling to an employee or a group of employees provides another option for selling your business in today's crowded marketplace. But is it the right decision for you? In general, if you need all of the sale proceeds upfront, it might be difficult to sell your company to an employee or transfer ownership to an ESOP.
On the other hand, if you can afford to receive sale proceeds over time and are concerned about maintaining the continuity of the business, then an employee-based sale is worth exploring--especially in the current marketplace.