(219)230-3600 support@ccsklaw.com

Keeping It Inside: The Benefits & Challenges of Selling to a Key Employee

For one reason or another, there will be a point where a business owner wants to sell their company. Maybe they are retiring, maybe they have other business endeavors they want to focus on, or perhaps they are simply going through some lifestyle changes. Either way, even if they plan on selling their company, a business owner generally wants to know that they are leaving it in the right hands.

To that end, one of the most common choices for a business owner looking to sell is to choose a key employee with their company to take over as the new owner. According to the 2019 Midwest Transaction Guide, selling to a key employee tends to have the best overall, long-term success,[1] making it beneficial for both the buyer and the seller. It also creates a sense of familiarity and security during what can a turbulent transitional period.

[1] Midwest Transaction Guide § 280.113, 2019.

The Benefits of Selling to an Employee

The most immediate benefit of selecting an employee to take over your business is that it is often faster and less complicated than other methods: grooming an outsider to serve as a successor requires a lot of time and energy[1], as does finding a prospective buyer that will meet the needs of the company. Sticking with someone close to the company also ensures that you’ve selected someone that knows your company’s culture and virtues, creating a sense of continuity and elevating some of the confusion that occurs when going from one owner to another.[2]                   This continuity addresses one of the biggest sources of conflict for a business undergoing a change in ownership: employees who aren’t on board with the vision of the new owner. If your employees aren’t onboard with your successor, it could seriously hurt the future of the business. If the new owner is an existing employee though, it circumvents some of the awkwardness that comes from new leadership, especially if they are well liked by their fellow employees. Additionally, an employee with your is also likely familiar with the company’s clients and supplier, which can help dissuade any concerns they might have about the state of the business following the change.[3]

[1] Orner, Randell, and Shannon Barr-Marinetti. “Following the Leader: Succession Planning for Healthcare Organizations.” 24×7 Magazine, http://www.24x7mag.com/2016/04/following-leader-succession-planning-healthcare-organizations/

[2] House, Bob. “Why Selling Your Business to an Employee May Be Your Best Bet.” Inc. 2016, https://www.inc.com/bob-house/why-selling-your-business-to-an-employee-may-be-your-best-bet.html

[3] House, Bob.

The Challenges of Selling to an Employee

Of course, for all of the benefits that come from choosing a key employee to take over as a new business owner, it also comes with its own challenges and conflicts. For instance, before selecting an employee to take over, it is important to make sure that they have the financial resources to purchase the business. This is an even bigger issue if the business has an intangible value, which can result in bad collateral.[1][2]

Also, even if the employee has the resources to acquire the business, they might not be the best fit for this type of leadership position. Your chosen employee might have demonstrated strong leadership skills as an employee, but an outstanding employee may not be a good owner, lacking the “personality, motivation, leadership capacity, or risk tolerance to wear an owner’s hat.”[3] Unless they have demonstrated experience in business ownership, you cannot know for sure if they will be a good fit for this new and challenging role. In addition, selling to a single employee often isn’t the most economical method, as a seller who is already in the same industry will almost always be able to pay more than an employee. For this reason, many business owners will perform a preliminary assessment to determine how much money the employer might be missing out on and whether or not it is worth taking a chance on an employee taking over. Either way, you need to make sure that you have a clear plan laid out to ensure their transition to ownership goes as smoothly as possible.

[1] Stoner, John S. “Pros and Cons of Selling a Business to a Key Employee.” Pennsylvania Institute of Certified Public Accounts.” Inc. 2018. https://www.picpa.org/articles/picpa-news/2018/11/29/pa-cpa-journal-pros-and-cons-of-selling-a-business-to-a-key-employee

[2] Midwest Transaction Guide § 191.39, 2019.

[3] Stoner, John S.

Making a Smooth Transition

It is always a bit difficult to leave a company that you once led, especially if you built it from the ground up, but choosing to sell to an employee can make the transition a bit smoother for both the business and you. It won’t always be an immediate transfer: employees rarely have the up-front cash to cover a 100% ownership transfer, so you might have to transfer the stock ownership of the business over a period of time rather than make immediate shift. In most respects, your transition should gradual, moving duties and responsibilities to demonstrate the capability of new leadership while limiting your own direct role in the company.  Another common method of transfer is to give the stock to the employee and given them a loan for the money that is paid through the cashflow of the business. However you choose to approach the transition, your goal should be to do whatever you can to position the new owner to succeed. After all, just because you are in charge doesn’t mean that you aren’t invested in the success of the company. By giving the new owner the time, vision, and support to ease into the role of business owner, you do right by yourself, your employees, and your customers.