Selling Your Small Business to an Employee

According to our experience and numerous surveys, most small business owners (<$10M enterprise value) intend to sell to an employee or family member. This can be a fantastic succession plan for many companies, especially closely held, private companies.

The benefits of selling to an employee include ability to overlap management for a time, preserve the identity and dignity of the seller and private financing between the parties. Most small business owners are also the manager/CEO. They can train up the new owner as a new manager in the way they like to see things run. This can also lower the risk for the new manager as they get to “learn the ropes.” The transition to retirement or some other life phase can also occur on a schedule that suits the seller. Because the seller is not handing over the keys all at once they tend to retain an option to stop if they are uncomfortable. Furthermore, many business owners have their identity tightly wrapped up in their work and do not desire quitting cold turkey. The team is a group of people that feels like family (or is family in some cases!) Finally, the buyer can often receive favorable financing terms from a seller note. The interest rates are often lower than a professional investor may require, and better than a savings account for the seller (we see +2% over prime in private notes versus +8% prime with professional mezzanine debt.) The repayment schedule may also be more flexible and can sometimes change on the business’ performance without repossession.

However, there are risks that many sellers do not wish to endure, including training a qualified candidate, securing reasonable timing and cold hard cash down. Foremost among these challenges is the absence of a qualified candidate. Many employees are highly skilled in taking direction but lack wisdom for establishing direction. Even if they are able plot a course, the seller may be biased by mistakes or differences the seller has observed in the employee. This is not true for all relationships, but in the absence of a qualified candidate (real or perceived) this situation negates all other positive prospects of selling to an employee. If a qualified candidate is available what about the timing of a transition? On a personal note, I wanted to buy out my father’s business but he did not want to sell just yet (maybe I wasn’t qualified?!) Understandably, he was too young and enjoyed his work too much, so I think it was a matter of timing. The final hurdle is plain old cash. Can the buyer come up with enough money down to squelch the repayment risk that the seller needs in order to close with peace of mind? Most sellers want 70% or more down or they will just keep running the business. This makes sense because the seller is trading future earnings for cash today. A bank loan may be an option but may add a large burden on the buyer.  This burden can impact the buyer’s ability to repay any private notes or earn outs.  Even without contingent payments, the seller probably cares for viability of the business after the sale, and the personal risk of the individual buyer. Either way, the seller will become acutely aware of these challenges immediately following closing, if not beforehand.

I think there are just a few viable options for small business owners without qualified employees interested and available to buy.

  1. Hire qualified employees that may some day buy the business.
  2. List your company with an intermediary and let them find a buyer. (High Transaction Costs)
  3. Sell to Little Engine Ventures (current record is 45 days between meeting and closing.)

This may seem presumptuous or over-simplified, but I can back up why these are viable options, and each path has it’s pro’s and con’s as well. But, I’ll save those for another post, or a personal email.