Exit Planning, Part 2: Selling Your Company to an Internal Successor

The basics for a smooth and successful employee-based business sale

The business-for-sale marketplace is crowded. For the past three years, the number of businesses on the block has hit record highs, largely driven by the number of retiring Baby Boomers.

Business resale site BizBuySell reported that 10,312 businesses sold in 2018—a 31 percent increase over the 7,842 businesses that changed hands in 2016, itself a record at the time. In the second quarter of 2019, uncertainty over whether trade tariffs between the U.S. and China would increase the cost of goods caused business sales to drop nearly 10 percent over the same period last year. But even so, sales remained at the second-highest level since BizBuySell began tracking data in 2007.

In the first installment of our two-part series on exit planning, we explored how to set your business up for a sale—even if your endgame is many years down the road. In this blog, we start to examine the prospects for finding an internal buyer.

An inside buyer gives you options

It’s key to understand that selling to an external party may not work in certain circumstances or market conditions—and selling to a trusted employee or group of employees can be a viable option for business owners contemplating an exit.

This has complications: selling to employees who often lack the assets and capital to purchase a business outright involves additional steps. Many times, business owners who choose employee-based succession plans must play an active role in funding or financing the transfer of ownership.

In fact, it’s not uncommon for employee-based sales to generate lower sale prices than the open market. A preliminary assessment using market multiples as well as getting an independent appraisal can help owners determine how much money might be left on the table by an employee sale versus searching for a buyer who is already in your industry. In some cases, an external buyer who is looking to take advantage of synergies by vertically integrating operations may be a more lucrative avenue.

In addition, some businesses simply don’t have any employees who are willing or able to take the helm. Or perhaps an owner’s “right-hand person” is exceptionally good at one part of the business—like running operations—but their skills in other critical areas like sales are untested. Before moving forward, it’s important to determine whether an outstanding employee has the personality, risk tolerance, leadership abilities, learning ability, and motivation to become a business owner.

But if business owners can identify the right individual or group– and maintaining the continuity of the business is important to them–setting up a succession plan that involves an employee-based sale can be worth exploring.

What are the biggest benefits of selling to an employee?

1. Continuity. You poured your heart and soul into building your business, and you care about what happens to your company after you move on. In addition, the completion of many business sales is dependent on the venture’s continued success for a period, whether the buyer comes from outside or within the company. A trusted employee is perhaps most likely to maintain the company culture and standards that you carefully crafted.

2. No need to find and sell potential buyers. In a typical sale, business owners invest a lot of time and energy in selling prospective buyers on the benefits of their companies. But since employees are already familiar with your business and realize its virtues, creating a sales marketing strategy may not be necessary. Selling to an employee also eliminates the hassle and expense of business brokers and the potentially drawn-out process of a third-party sale. That said, sellers should still explore all options that may provide better ROI.

3. Ease of transition. Obviously, a sale to someone who already knows the business inside and out leads to a smoother and faster transition. After all, the company’s staff, customers, and vendors already have a comfort level with the new owner. This makes it easy for outgoing owners to make a clean break since there is less of a need to stay on board after the sale to provide training and support.

Choosing a successor wisely

An employee succession plan requires a carefully structured buy-sell agreement. Your employee will generally agree to purchase your business at predetermined retirement date, or in the event of death, disability, or other circumstances that render you unable to run the business.

If you decide to move forward with an employee-based succession strategy, the biggest challenge you may face is choosing which employee to trust with your business. The earlier you put your exit plan in place, the better—giving you the most time to train your successor and entrench him or her in essential procedures and relationships at your company.

Zeroing in on an employee who is experienced, business-savvy, respected by your staff, and shares your value system can help smooth the transition when you are ready to leave.

Mind the complications: Keeping an internal successor around and making them financially viable

Once you have identified your successor, it’s vital to mitigate the risk that one day he or she may leave for greener pastures. Incentives like financial bonuses, staged financing to buy the business, “golden handcuff” retirement plans, exceptional work environments, and clear growth paths can go a long way toward retaining key employees. Even so, savvy business owners should have a predetermined Plan B in place in case the successor you choose decides to leave at some point.

In addition, perhaps the biggest challenge to selling the business to an internal successor is that they often can’t afford to buy you out. That said, there are successful strategies to make this happen, including seller financing, Employee Stock Ownership Plans (ESOPs), incremental stock transfers, and more. The key to making various options work is planning ahead.

In the next installment of this series, we zero in on the financial aspects—showing you how to make a chosen employee (or employees) viable to buy the business from you.

To learn more about how to implement HR solutions that benefit your employees and improve your bottom line, contact Karp HR Solutions today for a free consultation.