TKO Miller is a middle market M&A advisory firm
in Milwaukee, Wisconsin.
MILWAUKEE, June 21,
2024 /PRNewswire/ -- The following is a blog
post written by Tammie Miller, Managing Director, TKO
Miller.
An interesting way to exit your business might be to sell it to
an employee. Sometimes, there is an heir apparent. Other times, an
employee expresses interest in buying the business. In most cases,
the employee has plenty of knowledge about the business and desires
to own it but is lacking one essential element – money.
There are a couple of ways to transact with an employee. One is
a more traditional approach and the other will force you to think
outside the box a little.
The Traditional Way to Sell to an Employee
The traditional way to sell to an employee involves coming to
terms with a valuation of the business, creating a note, and then
using the profits of the business to make payments. The note is
generally secured by the stock or assets of the company (and
perhaps a personal guarantee from the employee).
There are a couple of things you will want to note here:
- You don't actually get any cash at the time of sale.
Your friends that are selling to third-party buyers get big checks
and buy boats, designer dogs, and summer homes, but you will be
receiving your payment over time – usually five to seven
years.
- Your employee/buyer can really mess things up and you might
not get paid. The company may have performed well under your
leadership, but if your employee/buyer can't keep things running
smoothly, your payments are in jeopardy.
- The valuation of the company can be tricky when you
are negotiating with an employee. Of course, you want to get full
value for your business, but employees have a tendency to
undervalue what the business would fetch if you ran a professional
sale process.
- If you can't come to an agreement with the employee/buyer on
value or terms and you decide to sell the company to a third party,
you may have a disgruntled key employee on your hands. There
is really nothing worse than explaining to a buyer how wonderful
your management team is, only to have them pout and not play nicely
during due diligence.
Think About a Management Buyout Using a Private Equity
Partner
This option can go one of two ways.
Management Buyout – Employee/Buyer Picks the Financial
Partner
You can allow your employee/buyer some time to find a private
equity partner who will finance the purchase of the business for
them. It goes something like this, "Mr. or Mrs. Employee, I will
give you 60 days to find a financial partner so that, together, you
can put together an offer to buy my business." Mr. or Mrs.
employee/buyer finds one of the 6,000 very eager private equity
firms in the US to engage and together they put an Indication of
Interest in front of you to buy the business.
Here are the downsides to this approach:
- The value or terms that they put together might not be
what you want. See point #4 above. You are stuck with a
disgruntled employee.
- Now you have a professional buyer in the mix (the PE group) and
you don't have a lot of negotiating leverage. What happens
when you can't agree on an escrow amount? Or other key terms in the
purchase agreement? You don't really have another buyer to turn to,
so you might be artificially inclined to accept terms that aren't
in your best interest.
- The employee/buyer has picked a partner, but if that doesn't
work out for you or they never make it through due diligence,
they are stuck without a backer. [Note: this is more
common than you might think. Private equity firms are interested in
buying almost any business…until they are not].
- You might want to try to sell the business yourself if things
don't work out, but you don't know what your employee/buyer has put
into the marketplace while he or she has been trying to attract a
partner. You have lost control of the marketing of your own
business.
Management Buyout – Seller Picks the Financial
Partner
"Wait just a minute!" you say "This isn't an employee purchase
at all. This is just me selling the business to private equity."
Hang with me here and I will explain.
You can run a sale process for your business, target private
equity buyers, and make it clear that the employee/buyer wants to
be an owner post transaction.
It can be structured this way:
– run an investment banking sale process – targeting private
equity buyers.
– create a "transaction bonus" for the employee/buyer – which he
or she can use to purchase equity once the deal is complete.
Private equity buyers will welcome this. A bonus doesn't need to be
huge, just something to get the ball rolling for the
employee/buyer.
– most private equity firms will put together option plans to
incentive management teams post-transaction which will give the
employee/buyer the opportunity to own more during the period of the
private equity ownership.
The benefits of this approach are many…
- You will receive a market-based (and higher) purchase price for
your business. It will probably be more than enough to cover the
transaction bonus you are paying the employee/buyer.
- You will have negotiating leverage during the deal process
because you will have other buyers if things get tense with the
first one you go down the path with.
- Your employee/buyer will have the benefit of being aligned with
whomever you choose to buy the business. Because you will have
pre-screened them for their willingness to work together with your
employee/buyer, they won't be stuck without a partner.
But there are also some challenges…
- You are limited to private equity buyers. If you run a
competitive sale process, you can be fairly certain that you are
receiving a full valuation. A process without strategic buyers
though, can leave out some of the buyers that have the ability to
pay the most. That being said, your investment banker can run a
very good and competitive process only including private equity
firms.
- Your employee/buyer might be unbackable. If your
employee/buyer is an irresponsible goof, it is going to be
difficult to find a private equity firm that will stand behind him
or her. Worse yet, the buyer could back him or her during the
process only to turn around and fire them later for being incapable
of leading the firm. My guess is that you wouldn't have such a
manager in your organization and if you did, that's probably not
the person you would pick to sell the business to but be honest
when evaluating your employee/buyer.
In summary, you can certainly sell your business to an employee.
I encourage you to understand the risks before you go down that
path and think of all the possible structures. There are plenty of
examples of transactions we have been involved in where
managers have successfully purchased the business in
partnership with private equity. Consult with an investment banker
if you think this might be the right path for you.
You will notice that I did not mention ESOPs – which are an
entirely different animal. In an ESOP, you sell your business to
many employees, not just an interested key manager. ESOPs have
gotten a lot of publicity as of late, but aren't always a
great answer for business owners that want the highest value
for their business
Contact:
Katie Yde
(414) 375-2660
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SOURCE TKO Miller