When most business owners are ready to sell their company, the first thing they think about is selling it to a third-party buyer. This would mean having to hire a commercial broker and putting the word out that your business is for sale. Then comes the waiting game where you must wait and wonder if anyone is going to purchase the business or not. If you get no buyers, then you must decide whether to lower the price, change the terms, or try to sell to some of the stakeholders of the company. Since finding outside buyers can be difficult, more business owners are discovering that selling their company to employees is the best option available.
To sell your business to its employees, you can create either a Management Buyout or an Employee Stock Ownership Plan. Each option has its pros and cons, so it really depends on the size of the company and the number of employees who are willing to step on board with this agreement.
Employee Stock Ownership Plan
The Employee Stock Ownership Plan (ESOP) is more like a retirement plan for the employees where they receive a bonus in the form of company stock, which gives them partial ownership of the company. The longer they’re with the company, the more stock and ownership rights they’ll have in the end. Company owners like the ESOP option because it allows them to turn over ownership to their employees over the course of time. That way, the owners can gradually phase themselves out of their responsibility in the company rather than just hand over their responsibility right away.
Of course, if the owners want to they can choose to sell off their company quickly to employees through the ESOP option. The only difference is the employees would have to come up with the funds to purchase the stock from the owner. Since most employees don’t have enough cash to purchase company stock outright, the ESOP would give the employees permission to take out a commercial loan and purchase the stock with that. The commercial lender would likely approve it because the collateral on the loan would be the stock assets of the company. The employees would then have to make monthly payments to the lender just like with any other loan.
Video: Selling your business to key employees - risks and side effects addressed. Canopy Law TV
In addition, the ESOP option provides great tax benefits to employees. Since the Internal Revenue Service qualifies ESOPs as retirement plans, employees can use tax-deductible money to repay the borrowed money that they used to buy the stock. This tax-deductible money is actually tax credits that do not have to be paid back to anyone. Therefore, the employees would be saving money and not having so much of their profits being taken away from the payments they make on the loan.
Related: Tax Aspects When Selling a Business
The management buyout (MBO) is a special kind of acquisition where the key managers of a company obtain either a majority of its ownership or all of it from the current owners or parent company. There is no stock options or retirement plans with MBOs like there are with ESOPs. The only similarity between the two is that managers who purchase ownership in the company need to take out a commercial loan, since they don’t have the cash available to purchase it themselves. However, commercial lenders usually require these managers to use a great deal of private financing towards the loan amount. A lot of this private financing is really just their own cash that they’ve contributed toward it. In other words, a lot of these managers would have to mortgage their house or take out a private equity loan just to secure the financing for purchasing the company.
Plus, managers cannot get the same tax benefits that they’d get with an ESOP option. The IRS does not allow MBOs to use tax-deductible money towards paying the debt owed. Managers have to use their after-tax dollars towards repaying their borrowed money. You might think this would be a good reason to use the ESOP option, but this isn’t always the case. The attractive feature of the MBO option is that it allows the owner of a publicly traded company to turn it into a private company. By doing this, it makes the transfer of ownership to the employees much easier and less of a hassle. Private companies don’t have to deal with all the paperwork, legislation, and costs that publicly traded companies have to do with during a sale. As a result, the managers receiving the company don’t have to deal with too many burdens after they take over.
Plan the Sale as Early as Possible
If you are ready to sell your business with either an MBO or ESOP, you need to make preparations for the sale at least 2 to 3 years in advance before starting the process. This will give you and the employees plenty of time to consider their options and to plan for the acquisition of ownership in the company. As the owner, you need to figure out the date that you will begin transferring ownership to your employees and the date that it will be completed. You also need to plan out what you’re going to do after the transition is done and how much money you expect to get out of it. Perhaps, you will want to start another business or retire after the transition is complete. It never hurts to think ahead like this.
Most important of all, will your employees be able to handle the responsibility of running the company. A lot of managers might be good at running various departments within the organization but this doesn’t necessarily mean they’ll be good at running the company. You need to have confidence that your employees will be able to continue making the business successful and that it won’t collapse as soon as you leave your business responsibilities behind. If the value of your business is already high, then it needs to stay that way. But if the value of your business is low, then perhaps you are selling the business because you believe your employees can make it better than you could. That is fine too.
No matter if you choose to go with an MBO or ESOP, the biggest benefit will be reflected in the attitude, morale, and productivity of the employees. Just take a look at the average employee of a company who does not own any stock or ownership in the business. They typically go to work just to earn a paycheck and pay their own bills. They do not have any real emotional investment into the success of the company that they work for. But this all changes when they receive ownership in it because now the success of the company determines how much money they’re going to make. Because of this, the employees tend to work twice as hard as they did before which increases productivity within the company. Not only that, but there will be a huge decrease in the employee turnover and absenteeism rates. This saves the company money because they don’t have to keep training new employees and they can keep the experienced employees around for a long time who know what they’re doing.