The Surprising Benefits of Selling Your Business to Employees

Selling your small business can be a challenging task when looking for the right buyer. However, have you ever considered selling it to your own employees?

This can be a win-win for you and your employees.

By doing so, you will be able to cash out the wealth you’ve created over the years of operating your business while preserving your legacy. It can also help maintain your operation's identity and culture, as well as its roots in the local community.

Furthermore, this will provide your most loyal employees with the opportunity to create their own wealth through business ownership.

Selling through a Management Buyout (MBO)

In an MBO, only a selection of employees become owners – typically members of the management team or key employees – by purchasing the company's shares from the existing owners.  

But in most small businesses, employees do not have the capital, the time, the knowledge, or the business management skills to complete an MBO and successfully run the business, so putting the business in their hands could be a daunting task.

Acquira can also facilitate this type of purchase and even be a capital partner to help financially sponsor and train the management team. If you're interested in this option, please fill out the form below to schedule a call with Acquira’s Business Transition Team.

Selling through Employee Stock Ownership Plan (ESOP)

An ESOP, on the other hand, involves all of your employees buying the company together. The ESOP has certain tax advantages unavailable to an MBO, as well as the ability to obtain significant leverage from banks. 

For those reasons, we will focus on ESOPs in this article – digging deep into their advantages and challenges. We’ll also look at an alternative option that may best set your employees up for success by partnering with Acquira.

What is an ESOP?

An employee stock ownership plan (ESOP) is a benefit plan that allows employees to own a company in the form of shares. Employee ownership plans can aid in succession planning by enabling employees to purchase shares from a departing owner. 

They are essentially trust funds that can be subsidized in several ways, including by using cash to buy existing shares of a company or borrowing money through the ESOP to buy shares.

They have a defined structure and must be run by an administrator. 

What are the advantages of selling to an ESOP?

Selling to your employees through an ESOP also offers tax advantages to the seller. 

Capital gains on the share of sales to the ESOP in a C-Corporation may be deferred by the owner as long as the ESOP owns more than 30 percent and the seller reinvests the proceeds into specific qualified securities, such as real estate, within 12 months of sale.

Selling to an ESOP avoids some of the pitfalls that occur when you sell to a private equity third-party. Those buyers often have a short timeframe and won’t necessarily protect your employees or workplace culture. 

Private equity buyers often have a five-year timeline to exit the business. That causes them to look for cost-cutting measures which could negatively affect the business you spent so much time building. 

Private equity will likely put in a new CEO and expect between 10%-60% of employees to leave during the transition. 

Selling to your employees can preserve your legacy and the identity of the business while maintaining its roots in the local community.

Selling to your employees can preserve your legacy and the business's identity while maintaining its roots in the local community. 

There is much less chance of high turnover – helping to preserve the existing jobs of your employees – and the business will essentially operate as it did before, only with a change in management. 

ESOPs can help to encourage employees to work very hard because they will share in the business’s success as owners. It can also help workers feel more appreciated and better paid. 

There is a strengthened alliance between employees and the company, as the better the company performs, the more income it produces that is shared directly with employees via the ESOP.

What are the challenges in selling to an ESOP?

There are several challenges to selling to your employees through an ESOP. 

It can be challenging to set up and administer the plan. 

Just understanding all the nuances of an ESOP is a lot of effort.  Do you really want to do this while at the same time working through a succession plan?  For many people, this is too much chaos all at once.

 It is also fairly expensive to do so. 

Price ranges from 50k to 400k, depending on the provider.  If you are using advisory services, the price ranges from 100k to 400k all-in. This includes legal, trustee costs, valuation costs, and advisory costs. You also have annual audit fees and administration fees (typically 1/3 of the above amount).

The other downside to an ESOP is whether your employees have the requisite business management skills to oversee operations successfully.

It’s not a great move for your employees if there isn’t a person or group of people who can step in and fill your shoes. The business will likely fall apart without someone at the helm who knows how to actually operate it. 

Acquira’s Alternative to a Standard ESOP

Given the difficulties with a traditional ESOP – whether your employees have access to enough capital and the management skills to run a business, as well as the high cost to implement and operate – Acquira recommends an alternative approach: Acquira’s Employee Buyout Program.

Acquira buys the business and sets up an ESOP or structural equivalent, in which the ESOP owns a percentage of the company equal to the seller financing in the sale. So, if the seller provides 40% seller financing, then the ESOP can own 40% of the company.

This will allow us to invest and partner with your employees to buy the business while also developing them as business leaders. 

Let’s take a look at an example before discussing the advantages of this approach. 

Let’s say your business is valued at $5 million. The deal would look like the following:

• Seller financing 40%: $2 million
• Acquira purchases the remaining 60% with $3 million in cash to the owner

The ESOP will be formed and will own 40% of the company. Employees will own shares of the ESOP, vesting every year, typically over 5 years.  Each year, the company will make tax-deductible contributions to the ESOP, and the ESOP will use some of this money to purchase shares from Acquira further until it eventually owns 100% of the business.  In these situations, it usually behooves the seller to act as an active participant in the business and help with a 6-12 month succession plan.

Advantages of this Approach

There are several advantages to implementing this strategy. 

First, as the owner, it lets you cash out on a large portion of the sale. Selling a small business can be challenging and take many months, if not years.   It also defers capital gains on the amount of the business that is sold to the ESOP.

This plan helps facilitate the transfer to 100% employee ownership.

Second, Acquira will actively invest in the business so employees don’t have to put money into the business out of their own pockets. 

Third, Acquira is very qualified at training and developing business leaders and management teams. We can help to create a succession plan and train the necessary staff so the business thrives under the new ownership arrangement. 

This will help align the interests of the seller, the employees, and Acquira. 

It is a win-win for you, your employees, and your customers. You cash out, and it has little to any negative impact on your employees or customers, the employees who have shown the most loyalty can receive a generous financial reward as owners, and Acquira works to take the business to new levels of success. 

The transition from owner-operated to management-run should take place in under a year. 

Conclusion

Selling your business to your employees can benefit both you and your workers. 

It can help avoid some of the pitfalls of selling to a private equity third-party, limiting staff turnover, and maintaining the business’s ties to the community. 

You can get the liquidity you deserve from the sale, and your employees can reap the financial benefits of all their hard work. 

One of the biggest challenges to this approach is whether your employees have the necessary business management skills to oversee operations. 

ESOPs also represent a significant cost to implement and operate, a reason why they are not common among small businesses.

Acquira exists to help business owners transition from owner-operated to management-led. And it doesn't matter if they're single owner-operators or a collective of employees buying a business. We can help oversee the ESOP and provide the leadership training necessary to get your employees up to speed on operating the business. If you're curious about what you're company is currently valued at, fill out the form below. You can also schedule a call with us to learn more about our ESOP offering through the form.

Key takeaways

• Selling to your employees can preserve your legacy and ease the transition in ownership.
• Employees need both the capital and management skills to take over your business successfully.
• Acquira can partner with you in a win-win scenario for all parties involved
• The transition from owner-operator led to a management-run company can happen in less than a year

Team Acquira

Acquira specializes in seamless business succession and acquisition. We guide entrepreneurs in acquiring businesses and investing in their growth and success. Our focus is on creating a lasting, positive impact for owners, employees, and the community through each transition.