Selling a Business to Your Employees or Managers

Who inside the company can buy it

Start by being honest about who you mean. A manager who has run operations for ten years and signs the checks when you are away is a different buyer from a group of line employees. A single strong second in command can buy the company with a lender's help and some of your own financing. A group of five managers can do the same, provided they agree about who is in charge. A full employee ownership arrangement is a larger project that usually needs outside trustees, a formal valuation every year and professional administration.

Then ask whether the person wants the risk. Being the best manager and being the owner are different jobs. The owner worries about payroll in a slow month, guarantees the bank loan, and cannot leave at five. Some very good managers decide, once they see the numbers, that they prefer a salary. Better to learn that over a few honest conversations than after you have told the whole staff.

You should also decide how much you want the buyer to be a surprise to the others. If you approach one manager and the others find out, you can lose the second and third people who keep the place running. Many owners speak to their attorney and advisor first, then to the chosen manager in confidence, and only then to the wider team. Our post on when to tell employees goes into the timing.

Where the money comes from when nobody has any

The price of a business is usually several times what a manager can borrow personally. That gap is filled by a mix of sources. A bank or SBA lender may finance a large share if the business's earnings can cover the loan payments. The owner can finance a share with a note. Outside investors can supply cash in exchange for part of the ownership. Sometimes a portion of the price is paid later and depends on how the business performs.

The lender will look at the business, and it will also look at the buyer. A manager with no ownership history and little personal capital often needs to put in some cash of their own, because lenders want the buyer to lose something if the business fails. If your manager has no savings, the structure may lean on you. Our guide to SBA loans in business acquisitions explains what these lenders ask for and what role a seller note usually plays in the package.

Be realistic about what that means for you. When the buyer has nothing to put down, your note can end up being most of the price, and you are then the lender to a company you no longer control. If the business stumbles, you are paid late or not at all. Some owners accept that for the right person. Others would rather sell the business to an outside buyer for cash and give the manager a bonus or a small ownership piece in the new company.

The honest way to test the idea is to price the business, then ask what monthly payment the company can bear after paying the new owner a fair salary. If that payment would take every dollar of profit in a good year, the structure will not survive a bad one.

Management buyout, employee stock ownership plan, or a smaller piece

A management buyout is the simplest form. One or a few managers buy all or most of the company, and the rest of the staff keep working for a new boss. The documents look like any other purchase agreement, with a promissory note if you are financing and a set of personal guarantees from the buyers.

An employee stock ownership plan is a trust that buys the stock on behalf of the employees, usually with money borrowed by the company and repaid from its profits over time. It can have tax advantages for the seller and the company, and it can let an owner sell in stages. It also has costs. There are legal and valuation fees, ongoing administration, and a duty to treat the plan's members fairly. The company has to be big enough and profitable enough to carry all of that. Your accountant and attorney should tell you whether the tax treatment suits your situation, because it depends on how your company is organized and on rules that differ by state and by circumstance.

A third path is to sell part now and part later. A manager buys a minority stake today, perhaps with a note, and an agreement sets the price and timing for buying the rest. This gives you a chance to see how the person behaves as an owner before you commit. It also leaves you in the business longer, and you need a clear agreement about who makes decisions while you both hold shares.

What a buyer who works for you will ask for

Employees tend to see more of the business than outside buyers, and they are also less likely to ask for proof. That is a mistake in both directions. A lender will still want the full set of records, so the financials need to be in good shape regardless of how well you all know each other. Our post on getting your financials ready for a buyer walks through what a lender and an accountant will want to see.

The manager may also be surprised by what they find. An employee knows what the company sells and how it runs but may never have seen the owner's compensation, the loans to and from the company, or the personal expenses that sit in the books. Once these are laid out, the buyer sees what the business pays after the owner is gone, and sometimes the number is lower than they imagined. That is a reason to discuss add-backs openly and early. Our guide to what counts as an add-back is a good primer for the manager, too.

Expect questions about the things you have always handled personally. Who has the relationship with the largest customers? Who negotiates with suppliers? Who holds the licenses, and who is named on the lease and the insurance policies? The answers show how much of the business is built around you and how much can pass to a successor.

Protecting yourself in an insider deal

When you sell to a buyer you know and like, the instinct is to trust. The paperwork should assume the relationship will be tested. If you are holding a note, you want security, which might mean a lien on company assets, a pledge of the stock, or both. You want financial reporting rights, so you can see the monthly results while you are owed money. You want limits on what the new owner can do with the company until you are paid, such as taking large distributions, selling major assets or borrowing heavily against the business.

You also want to think about your own role. Owners sometimes agree to stay as a consultant for a year, and the new owner finds it hard to establish authority with the old boss in the building. A clear end date and a clear job description help both sides. Our guide on how long you stay after selling talks through what is normal.

A non-compete is usual in any sale, including a sale to a long-time manager. It may feel awkward, since you trust the person. It protects the value of what they are buying, and it protects you if a competitor tries to hire one of your former staff to start something new. Your attorney can draft it so that it is fair in scope and length.

Keeping the option of an outside buyer

Even if the manager is the first choice, treat the inside sale as one option and not the only one. Owners who offer the business to an insider without ever testing the market sometimes learn later that an outside buyer would have paid more, or paid it in cash. Others find that the insider could not get financing at the price the owner needed.

A parallel process can be done quietly. We can value the company, prepare the materials and identify the kinds of buyers who would be interested without naming the business or alerting the staff. If the manager's offer holds up, nothing is lost. If it falls short, you still have a sale to run.

Your manager might also be better off with an outside buyer in the picture. A new owner with capital and a plan may keep the manager in a senior role with a meaningful stake, which can be a better result than a stretched buyout financed by a bank and the old owner.

Where to begin

Write down the three or four things in the company that only you do, then find out whether the person you have in mind can do them. If you have not asked the person about ownership, ask in a private conversation without making a promise. Get a valuation, so both of you start from an outside number. Have an accountant look at what you would net after tax under a cash sale and under a staged sale with a note, since the difference often decides the question.

When you have those answers, you will know whether to build an inside deal, an outside deal, or a hybrid. Business Advisors of America can help with all three, and a first call costs nothing but your time.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.