Selling a share of your business (or the entire business) to an employee is often overlooked as a strategy, yet it can be very beneficial for both the owner and employee. There are many different ways this can be achieved and different situations where it might be beneficial. It is also possible that the owner can negotiate a better price as the employee may not have the capacity to purchase the business without the owner’s added assistance.
How does it Work?
One of the reasons why this strategy is attractive is that you can tailor it to meet the requirements of the business, the owner and the employee. There are no fixed rules, work out what both parties need for the deal to be beneficial and it’s a negotiation process from there.
The essential part of the transaction is that the owner will be entitled to receive a payment in return for giving the employee ownership or part ownership of the business.
The following variations can exist
- If the employee does not have the funds or the capacity to borrow the purchase price, then
- the purchase price can be paid over a number of instalments
- the owner can personally guarantee the loan (in the employee’s name) and a separate agreement which entitles the owner to retain ownership of the business sold if the guarantee is activated
- If the employee does not have the capacity to establish their own business premises then the employee can pay a rent and administration fee to the owner
- The employee may purchase only one income stream of the business (and the owner continues to operate and own the remainder of the business)
- The employee may purchase a share of the entire business (which could be Stage one of a number of stages to acquire the whole business)
What situations would it be beneficial?
Some examples which would suit this strategy:
1. The owner requires cash for personal reasons and financing is not an option
Peter owns 3 toy stores which are trading very well. However Peter borrowed heavily to invest in an Aged Care Venture recommended by a friend. The Aged Care Venture has filed for bankruptcy and Peter is struggling to meet his debt obligations personally. The business operated an overdraft and the bank is not willing to lend any additional funds.
Paul has been a store manager for 5 years, and has previously spoken with Peter about purchasing the business or part of the business, but Peter had declined as he felt he would sell the entire business when he plans to retire in 5 years.
Peter and Paul negotiate for Paul to purchase 20% of the business for $50,000.
2. The business is largely dependent on the owner and therefore difficult to sell to an “outside party”. However, through a staged process, the business and its value can be transferred from the owner to the employee
Neville provides engineering consulting services to large mining companies. Almost all of the income is from 4 mining companies that he has consulted to for over 10 years. Daniel is a qualified engineer who has been an employee for 5 years assisting Neville on these contracts (the business also employs 1 engineering undergraduate and 1 administration staff member). Neville wishes to retire.
It is unlikely that this business is saleable to anyone except Daniel. It is also likely that Daniel would not be awarded the contracts himself without Neville’s assistance.
Daniel agrees to purchase the business effective immediately – the deal is
- 50% of the purchase price is paid now
- 50% of the purchase price is payable in 12 months if the mining companies agree to maintain the contracts after Neville’s departure
- Neville agrees to continue in the business for 12 months and is paid a salary
3. The owner wishes to offload part of the business to allow another part of the business to grow OR an excellent employee will leave without being rewarded with ownership.
Annette owns a business that distributes cleaning products. The business has 3 distinct income streams
- Wholesale of cleaning products to 3 large corporate clients. Annette has known these clients and has been distributing to them for 15 years. Profit on these products is high.
- Retail of cleaning products to restaurants within a 200km radius. Carol is the manager who looks after this division, and whilst sales growth has been good, profit margins are lower as there are a number of competitors in this market.
- Annette has developed an innovative cleaning product which is suitable for hospitals. This product has significant potential but Annette will have to invest a lot of time to commercialize, trial and distribute the product.
Carol works long hours and has done a great job with the retail division. Carol is enthusiastic about new products that could be sold through the retail network and has some other ideas to increase profits. Annette however does not have the time, nor the interest to invest money into this division, especially when the same time and money spent on the hospital product could produce much higher profit. Carol is frustrated at this lack of interest and is deciding whether she should approach a competitor to employ her. Carol has been repaying her university debt and does not have much money.
Annette and Carol agree as follows
- Carol will purchase the retail division for $200,000, payable immediately
- Carol is unable to obtain finance for $200,000 by herself, so Annette agrees to personally guarantee the loan. They sign an additional agreement which states that if the personal guarantee is called upon then Annette will be entitled to retain the Retail business. The loan term is for 4 years.
- Carol will pay a Rent and Administration charge to Annette of $2,000 per month for the use of the office, staff and equipment.
DISCLAIMER: Many of the comments in this publication are general in nature and anyone intending to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the information’s applicability to their circumstances. The author expressly disclaims all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything done by any such person in reliance, whether wholly or partially upon the whole or any part of the contents of this publication.
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The author is a Chartered Accountant with 24 years of extensive experience assisting businesses in many industries and sizes. The author currently owns and operates Dignan Stephens Accountants, a successful accounting firm.