Although only sometimes considered a good strategy, selling a portion of your business or the entire business to employees can prove very profitable for both the employee and the owner. This can be done in many ways, and there are different circumstances where it may be advantageous. The owner may be able to negotiate a lower price because the employee might need more financial means to buy the business.
What does it mean?
This strategy is appealing because it can be tailored to suit the needs of the business, owner, and employee. There are no set rules. It’s up to you to determine what each party needs for the deal, and then it’s time to negotiate.
The most important part of the transaction will be that the owner is entitled to a payment in exchange for the employees or partial ownership of the business.
These variations are possible.
- If the employee doesn’t have the money or the ability to borrow the purchase price, then.
- The purchase price can be spread over several installments.
- The owner can personally guarantee the loan in the name of the employee. A separate agreement allows the owner to keep ownership of the business if the guarantee is activated.
- Employees who need help setting up their business premises can still pay rent and administration fees to the owner.
- An employee can only purchase one income stream from the business while the owner remains in control and owns the rest.
- An employee could purchase a part of the entire company (which could be Stage 1 of many stages to acquire the whole business).
In what situations would it be useful?
Here are some examples that would work with this strategy:
1. Personal reasons require cash, and financing is not an option for the owner.
Peter has 3 very profitable toy shops. Peter borrowed heavily to purchase an Aged Care Venture that a friend recommended. Peter is now struggling to pay his debts as the Aged Care Venture filed for bankruptcy. The bank won’t lend additional funds to the business because it had an overdraft.
Paul, a 5-year store manager, has spoken to Peter previously about buying the business or a portion of it. Peter declined because he believed he would sell the whole company when he retired in 5 years.
Paul and Peter negotiate for Paul to buy 20% of the business at $50,000.
2. It is difficult to sell the business because it is heavily dependent on the owner. The owner can transfer the company and its value through a gradual process to the employee.
Neville offers engineering consulting services for large mining companies. Nearly all of his income comes from four mining companies Neville has been consulting for more than 10 years. Daniel, a qualified engineer, has worked for Neville for five years as an employee. The business also has 1 undergraduate engineer and 1 administrative staff member. Neville would like to retire.
This business will not be sold to anyone other than Daniel. Neville would likely have assisted Daniel in obtaining the contracts.
Daniel agrees to buy the business immediately.
- 50% of the purchase price must be paid now
- 50% of the purchase price will be repaid in 12 months if Neville and the mining companies agree that the contracts will be kept after Neville’s departure
- Neville accepts to stay in business for 12 more months and is paid a salary.
3. Owner wants to sell a portion of the business to expand the business. Or, an outstanding employee may leave the company without being rewarded.
Annette runs a company that distributes cleaning products. There are three income streams for the business.
- Three large corporate clients are customers who require cleaning products wholesale. Annette knows these clients and has been selling to them for over 15 years. These products make high profits.
- Restaurants within 200km of the company can be sold cleaning products. Carol manages this division. While sales growth has been positive, profit margins have been lower due to the number of competitors.
- Annette has created a unique cleaning product that is safe for hospitals. Annette will need to spend a lot of time trying to market, test and distribute this product.
Carol is a hard worker and works great in the retail division. Carol is excited about the possibility of selling new products through the retail network. She also has other ideas for increasing profits. Annette needs to spare the time or money to invest in this division. This is especially true when Annette could make a much greater profit by investing the same amount of money in the hospital product. Carol is annoyed at her lack of interest and is considering approaching a competitor for employment. Carol is currently repaying university debts and has little money.
Annette and Carol agree as follows.
- Carol will buy the retail division at $200,000 immediately.
- Carol cannot obtain financing for $200,000 on her own, so Annette agrees that she will personally guarantee the loan. Annette agrees to sign an additional agreement that states Annette can retain the Retail business if Annette’s guarantee is needed. The loan term is 4 years.
- Carol will pay Annette a Rent and Administration fee of $2,000 per calendar month to use the office, staff, and equipment.