Sale to Management or Key Employee

By Claudio Martellacci and  Nick Rotundo

Grewall Guyatt LLP

In previous posts on the topic of succession planning, we highlighted transition options available to owners looking to sell their business.

Transferring a business to management or key employees is an attractive option as an alternative to family succession or a sale to an external party, particularly for business owners who feel strongly about maintaining the corporate culture and values post-exit. Examples of these types of buyers include executive or senior management, as well as operational or divisional managers.

Advantages of Selling to Management or Key Employees

• Smoother Transition: Transitioning the business to existing management or key employees is more likely to result in a smooth transition, since the remaining staff will be more familiar with the faces and personalities of those in charge, and are more likely to continue the operations of the business without significant changes.
• Seller Involvement Post-Transaction: The sale of a business to employees may offer the seller the ability to remain involved in the business in some capacity, while “cashing-out” their interest. This interim step can provide a safeguard to ensure a successful transition occurs, and make the transaction more attractive to both the buyer and seller.
• Higher Rate of Success: Businesses acquired by employees have a higher rate of success, as employees already have essential industry experience and abilities, as well as existing relationships with employees, customers, and suppliers. External sales are typically more complex, time-consuming, and may not even close after the due diligence phase.
• Flexible Sales Process: An advantage of selling to existing employees is that the buyer is identified from the outset. As a result, sellers save the time and costs of identifying potential acquirers by marketing the business, as well as expensive broker fees. This can assist both the seller and buyer in proper structuring of the transaction for operational and tax purposes, since there is less pressure to close in a short period of time.
• Confidentiality: Maintaining confidentiality is simpler when selling a business to employees, since there is a reduced risk of breach of confidentiality. Existing employees may already be familiar with the business, including key customers and supplier information, as well as the wider operations of the business.
• Employee Stock Option Plan (ESOP): If an owner wants to remain in control of their business but have some flexibility on the transition out of the business, an ESOP plan enables employees to
  co-own part of the business while allowing the owner to only sell a portion of their business over a period of time.

Disadvantages of Selling to Management or Key Employees

• Financing: One of the most common reasons business owners do not sell internally to management is a lack of sufficient financial resources available to the buyer, which makes an internal sale more difficult. In addition, a lack of financial resources generally means that the seller will receive the proceeds over a longer period of time.
• Lower Price: An employee purchase will not typically generate synergistic benefits for the buyer, which could result in a lower price compared to a sale to an external party (e.g. a larger competitor). In addition, the offer price for a business from an employee is mostly determined by the amount that they can afford, which could be lower than the fair market value of the business.
• Seller Involvement Post Transaction: The relationship between the buyer and the seller may be more personal in nature, given the history and length of time together. This may result in an over-reliance on the seller post-sale, wherein the seller feels obligated to assist “a friend”, which may not be preferred by sellers looking for a “clean-break” from the business.
• Impact on Existing Employees: If employees are negotiating to buy a business, this may affect other employees that may have been overlooked, particularly those who do not feel that the new successor is a capable or desirable leader. The buyer and seller must consider the impact of the transaction on existing employee relationships.
• Difficulty of Employees Transitioning to Ownership: Any individual who has promoted staff into more senior leadership roles will know that some employees are not well-suited for the increased duties and responsibilities. Employees may be strong performers at their job, but may lack the leadership qualities necessary to run a business. Becoming a business owner entails enormous responsibility, tenacity, and drive to make their companies succeed, so this must be considered, especially for owners looking to have the business continue once their involvement ceases.