Chuck Hanley and George Schubert founded their events-management and audiovisuals service in 1977, intending to sell out to employees in 1988. The partners expected their plan (detailed by Inc. in May 1988) to provide them with a smooth exit and to allow employees to buy the company -- Light & Power Productions, in Scotia, N.Y. -- without mortgaging their homes. The founders' failure demonstrates how not to handle a buyout.

Hanley and Schubert settled on a sale price of two times retained earnings, which they guaranteed would not exceed $300,000. That arbitrary valuation could have bred resentment -- and even a lawsuit. Many major valuation firms now staff experts in employee buyouts who can calculate a fair price.

Employees were to pay half the $600,000, plus interest, out of company profits over seven years, and half in cash borrowed against pension and profit sharing. In 1988 new tax laws precluded such borrowing. Some employees got loans from family and friends, and some did mortgage their homes.

If Hanley and Schubert had sold the company through a formal employee stock ownership plan, they could have deferred capital gains, and the employees could have bought the company with pretax dollars. Or Hanley and Schubert might have sold stock into the profit-sharing plan, forfeiting the capital-gains deferral but still getting a tax break for employees. Corey Rosen, executive director of the National Center for Employee Ownership, in Oakland, Calif., estimates that employees paid 40% too much.

Ill-prepared for their new roles, employees named as president Al Marden, the top salesman, but they didn't take his direction. As owners now, they wanted a say. So the company expanded its board of directors to include 5 employees (out of 16 employees total), and the board met, as Hanley puts it, every time the grass needed mowing. As the board dithered, the $2.5-million company stalled. Hanley and Schubert hopped on and off the board. After three years the company hired a new president, Peter Ross. Under Ross, formerly a small-business consultant, the company is growing again.

"We had to go through that exercise in consensus," Hanley says. "If I'd brought in a CEO at the beginning, employees would have wondered, 'What's the change? We're still just employees." Now, while they still believe in employee ownership at Light & Power, they understand it need not mean day-to-day management.

Unfortunately, Light & Power's employees seem to have lessened their involvement. Rosen says if the partners had prepared employees, they could have made it work. "You've got to define the role employees will play as managers," whether that means they serve on the board or advise it; whether they help determine overall management or just manage their own jobs. In any case, you must make sure they know ahead of time.