Does the prospect of putting your business on the market give you the willies? Having prospective buyers wade through the intimate details of your business operations not for you? Then you have probably given some thought to selling your business to insiders. This is a popular exit route with a 2011 survey by the Business Enterprise Institute finding that 41% of owners would like to sell to key employees. However, not all of these owners succeed.
There are two major potential problems with sales to employees—they don’t have the financial resources to buy and they don’t have the leadership skills to run the business. In the right circumstances, employee buyers might be able to obtain bank financing. They typically need to demonstrate the ability to manage the business and acquire a small equity stake—through some creative structures such as a stock bonus or a purchase of a heavily discounted minority interest—before approaching a lender. Small Business Administration guarantees are available for loans up to about $5 million and banks will lend on good terms with these guarantees in place.
But what if, after a careful assessment, you determine that your key employee(s) don’t have the leadership skills to keep the business on track? Note the precondition “careful assessment”. In my experience, business owners frequently assume that their employees can run the business. They tend to assume that employees have the same entrepreneurial spirit and passion to succeed that they have. Business owners, among other virtues, tend to be an exceptionally generous group. They recognize that key employees have helped them make the business successful and want to reciprocate by giving these persons the chance to run the business. But to their surprise, after a “careful assessment”, owners are sometimes forced to conclude that key employees are not the right persons to sustain their business legacy.
Sometimes after surveying the scene and reaching such a conclusion, and still not willing to go the route of a sale to an outsider, our fearless owner will say, “Why don’t I try to find someone who can replace me as CEO?” For a small business in which leadership and ownership reside in the same person(s), this is a daunting challenge.
Insider ownership transitions take time. As we mentioned above, before trying to obtain financing, the prospective buyer must demonstrate the ability to manage the business and acquire a minority stake. The owner must become comfortable that the newly hired heir apparent is in fact a good fit for the company. This is a process that will not happen overnight—figure a minimum of two years. Then once we are all comfortable with the situation, we need to transfer some ownership to the heir in a tax and financially friendly way so that when we go to the bank the buyer has some equity in the company. If we use a stock bonus program, discounted sale of a minority interest or some similar techniques, we will need more time—probably at least two or three years. But if we don’t get comfortable with the situation, and decide that our new hire is not a good fit, we have to start the process all over.
Did I mention the “heir apparent” problem? Put yourself in the position of those key employees who we passed over for ownership for good reason. They might be perfectly happy working for you. They respect the fact that you grew the business and made it successful. But how are they going to feel about a newcomer who they perceive as getting the silver spoon treatment—not having to put in years of hard work and proven success in order to get the brass ring? Management consulting types will tell you that it is preferable to have an “orderly competition” for a leadership post so that all possible candidates feel they got a fair shot. Bringing in an “heir apparent” is not a good recipe for a cohesive management team.
But perhaps the major challenge here is, where do I find my knight in shining armor? Most persons looking for a job are just that—potential employees. If they possessed the entrepreneurial spirit and passion to succeed necessary to become your new CEO would they be interested in coming to work for you or would they have already started down the path of entrepreneurship? It is true that there are some folks out in the business world who are chomping at the bit to become entrepreneurial business owners. But finding such a person who will be the right fit for your company is a large challenge. It is not impossible and it has been done successfully but you should not underestimate the challenges when comparing this path to other options.
Published in Business2Business magazine (Lancaster edition), December 2014