Most business owners today have nearly all of their personal net worth locked up in their business, meaning that their retirement security is tied to their ability to sell the company.
But when asked about their succession plans, most owners can’t articulate their plan to monetize their business value, they have been too busy running the business and surviving the economic turmoil.
For those that have explored selling to an outside 3rd party, a rude awakening if often waiting. Most deals today come with a long list of “strings” that frequently include:
- Required long-term employment by the owner/sell (3-5 years).
- Relatively low initial down payment (40% is probably a good average right now). Significant “at risk” money in the form of an earn out. If the business doesn’t perform, you might not get the rest of your money.
There is an option that is often overlooked – your employees. Many owners quickly dismiss the employee buyout option because they “don’t have any money”. While that is certainly almost always true, is doesn’t mean that it isn’t a viable option. And sometimes even the best option.
Done properly, employee buyouts can create some significant advantages over outside buyers. First and foremost is the ability to create a true win-win. As opposed to the adversarial negotiation process of a 3rd party sale, a properly structured employee buyout can be based on “how can we best structure this for all of us to be successful”. This takes advantage of the long-term relationships…and the long-term need for both parties to be successful.
What we often see as a result is significantly more financial creativity and flexibility – helping to minimize taxes. Translated, the seller can NET more money from the deal, while the buyers actually pay less. Everyone is happier and the deal is actually significantly less risky.
And if money upfront is highly desired, there are reasonable financing options that exist where banks actually prefer to lend to someone with critical experience (i.e. a key employee). It won’t get you all of the value upfront, but it can be a significant lump sum.
Consider a client of mine where we recently celebrated the 5-year anniversary of signing the deal to sell the business to the key employees. When I initially met them nearly two years before that, Mike (the owner) felt certain he would have to do a controlled shut-down of the business. It is a professional service business, with very little in the way of assets to either sell or borrow against. Likewise, there wasn’t much of a market for 3rd party buyers – and those that were interested wanted too much from Mike with too little reward. Mike simply dismissed the employee option since “they had no money”.
We spent 2 years on this project, running parallel paths. First was working out a financial structure that treated both sides fairly. Second we had to develop and implement a strong training program to make sure the 3 key employees were ready to assume the leadership of the company (both internally and externally with clients).
Five years later we are looking at having the deal paid in full by the end of this August, with the new owners ecstatic about their ongoing business. Mike couldn’t be happier about the impact his company is now having on their three families, not to mention the rest of the employee base that didn’t see their jobs lost to the shut-down.
And the even better news for Mike is that we structured the financials in a manner that allowed him to get an additional 25% NET from the deal that what would normally have occurred – making his retirement even more secure.
There is no question that these employee buyouts create a longer-term mutual dependence. Both sides need the buyers to run the business successful to be happy – at the very least for the years the buyers will be making payments. As such, we are really careful to adhere to the following principles:
- Get started early. Define deal parameters early on, even a few years before the actual deal. It makes it real and tangible.
- Focus on the Transition Plan. Craft and implement a plan to make the owner/seller obsolete to the company BEFORE the deal closes.
- Identify gaps in capabilities for the buyers and design a method to close those gaps – again before the deal closes.
- Approach the design of the structure as a joint design. Don’t have one side create an “offer” for the other side to consider. This very quickly could spiral into a very negative negotiation process – risking your working relationship (and the stability of your company).
Finally, we advocate hiring an advisor to design the deal from the middle ground. Representing neither buyer nor seller. This dramatically increases the likelihood of a true win-win deal getting done.
Questions to consider:
- Do you have a true succession plan that you are working to – even if you are 10+ years away from selling?
- Have you properly considered selling to key employees?
a. If so, how did the option look and what could make it better?
b. If not…why not?
Chad Blevins founded Blevins Financial to serve the complex financial and estate planning needs of the closely-held business owner and high net worth individuals. His focus on combining an overall estate planning strategy with life insurance analysis positions him to serve clients in a more comprehensive -- and often more simple -- manner.
He has held executive leadership positions in Fortune 500 companies (GE, Honeywell, MagneTek), private start-ups as well as family-held businesses. His experience includes executive positions in Sales, Marketing, Business Development, Finance, Operations and M&A work. This diversity of experience allows him to work in a highly comprehensive manner in dealing with client’s personal and business objectives.
Chad is a Board of Directors member for the Northwest Family Business Advisors, which focuses on teaching advisors how to work together for the client’s benefit. His level of expertise and desire to educate has also prompted speaking engagements with the following organizations:
Washington State CPA Association Association of General Contractors (AGC)
National Electrical Contractors Association (NECA) Approach Management Systems/Smart Association Northwest Family Business Advisors.
Chad was a recent honoree by the Puget Sound Business Journal as one of the “40 Under 40" top business people in the Puget Sound area, recognizing his contributions to both the business and charitable communities.
Chad is married, has two children and is active with various charities serving those with Autism and other disabilities. He holds an MBA in Finance and Marketing from Indiana University and has undergraduate degrees in Business Administration and Economics. Chad enjoys skiing, golfing and is an active coach for local Little League teams.