How do I sell my business to a key employee?
March 20, 2023 ⋅ 8 min read
We work with many small businesses looking to sell – and many are often curious about handing over the reins to a key employee. Oftentimes, your business is your life’s work and you’d like to see it end up in good hands. Selling your business to key employees can be a great solution for when you're ready to move on, but don't want the business to lose the things that make it special. Oftentimes the employees at your company are akin to family so there is a good chance that if you’re considering this route - you think that the business would be better off with one of your employees taking it over.
In this guide, we’ll break down the pros and cons of selling your business to a key employee so that you can make an informed decision about what is best for you and your company.
Why sell to an employee? Advantages of an exit to a key employee.
Selling your business to a key employee can be a great option for many reasons. It allows you to pass on the legacy of your business and ensure that it is in capable hands after you leave. Additionally, this option gives the key employee an opportunity to own something that they have been working hard for and (hopefully) maintain the same level of success that you have achieved or even take the business to new heights. Selling to an employee can also be a great way to reward them for their hard work and dedication.
Some of the advantages of selling to an employee include:
Ability to get an SBA loan
While selling to a key employee isn’t a requirement to qualify for a loan from the Small Business Association, these loans may be more accessible if you decide to do so. Most SBA lenders are storied lenders, which means they look specifically for buyers who are likely to sustain the business. Because a key employee is more likely to know what they’re doing, you may be more likely to get an SBA loan.
Increased loyalty and retention
By selling your business to a key employee, you are rewarding them with ownership in the company they have helped build and contribute to its success. This increased loyalty can lead to higher retention rates for your employees, ultimately leading to better long-term outcomes for the company as well as overall morale among staff. Think about the flip side of this - if you sold the business to a private equity firm and they came in and started making a bunch of changes, employees may very well quit and look for greener pastures.
A common reason companies fail after a sale is that the new owner doesn’t fully understand the business. Selling to a key employee can mitigate some of that risk. When an employee takes on ownership of a business they are more likely to ensure that it remains sustainable in the future since their livelihood depends on its success. This allows the business owner some peace of mind knowing that their legacy will be continued even after their departure from the company.
An exit strategy involving a key employee can be financially beneficial both for yourself, who receives payment in return for selling a stake in the company, but also benefits employees whose salaries often increase upon taking ownership of a portion of the venture’s profits/resources. This is why it’s essential to have an earnout structure that financially benefits you.
Selling your business can be a grueling process with multiple potential buyers doing heavy diligence, this can drag on for 9 months or more. All while you have to keep the business afloat, likely hide the sale from your current employees, and be in intense negotiations. Selling to a key employee will hopefully be a simpler process than running a full sale process to find a buyer since the employee is already comfortable with the business and you know who the buyer is going to be.
Disadvantages to selling a business to a key employee
Your small business is often the result of your life’s work, so it’s important to leave it in good hands. Here are some of the downsides to selling your business to a key employee.
Potential lower price
Not all employees will have the capital to purchase your business and it may be hard to negotiate for a higher price, which means you may not get the best possible price for your business. You know how much your employees are paid so it is very likely you won’t get the same sale price.
Lack of knowledge
Although key employees may be familiar with the operation and running of your company, they may not have the same level of expertise as you do when it comes to making decisions about the future or growth of the business. This could lead to mistakes that could cost the company in terms of finances or reputation.
By understanding the pros and cons of selling your business to a key employee, you can make an informed decision about what is best for you and your company. Consider all the potential risks and rewards before making any decisions and be sure to seek advice from experts if you are unsure.
Top mistakes to avoid
Selling to key employees can be an especially effective way to ensure continuity after your departure – but of course, you have to do it right! Knowing what mistakes to avoid when selling your company to a key employee is essential in order for the transition to go smoothly. As a business owner, you want to successfully pass their companies onto someone they trust and ensure their legacy is in good hands.
Here are some of the top pitfalls business owners may face when selling to an employee.
Mistake #1: Not having a clear agreement in place
It is essential that you have a clearly defined agreement between you and the employee to avoid any potential misunderstandings or disagreements down the line. A legally binding document should be created defining who owns what percentage of the business, how profits will be distributed, and any other terms that need to be clarified. You should work with an experienced M&A attorney and maybe even an M&A advisor to secure the deal.
Mistake #2: Not doing due diligence
Before selling your business to a key employee, it is important to do some due diligence in order to make sure that the individual has the necessary skills and experience to take over the company and continue its success. This is especially important if you’re utilizing seller financing in your deal. Due diligence includes researching their qualifications, past job history, and any other relevant information that can help.
Types of deal structures
Once you’ve determined who you want to sell your business to, now you get to determine how to sell your business to get the best possible deal.
In other cases, there are a few other ways to structure the deal, depending on your cash needs and how much control you’re looking to relinquish:
Seller financing, also known as a long-term installment sale, is a type of deal structure where the total sales price for the assets is paid by the buyer over time, typically through fixed payments that are spread out over several years. This type of sale may be attractive to both buyers and sellers as it can provide flexibility from a tax perspective, allowing buyers to acquire assets without needing large amounts of cash all at once, and lets sellers receive greater returns overall than normally allowed with other types of transactions – since they’re essentially earning interest on the unpaid portion of their proceeds.
Employee Stock Ownership Plan (ESOP)
An Employee Stock Ownership Plan (ESOP) is a trust that holds company shares exclusively for the benefit of employees. When the ESOP is established by a business owner who wishes to sell their company, they use it as part of the sale process to transfer ownership to the employees. As opposed to traditional methods of selling a business, this approach can provide tax advantages to both buyer and seller while also creating employee retirement benefits. ESOPs also offer an incentive structure that encourages employees to increase productivity and profitability. This can be an excellent way to retain talent while also giving employees ownership and incentive to help grow the business.
How Baton can help
If you’re considering selling your business to key employees, it’s important to make sure that you have a realistic idea of what your business is worth. Once you have a clear sense of what your business is worth, you can move forward with confidence in finalizing a sale agreement that benefits both you and the employees who will be taking over the company.
Baton offers a free business valuation to help small business owners understand if selling their business is the right decision. If you're not ready to sell, Baton provides guidance on how to increase their business valuation. If you decide that selling is the right move, one of our full-time transaction advisors with decades of experience can work with you throughout the process. We also partner with lenders and lawyers to help you structure the best possible deal for your business.