Control of companies changes all the time. Whether passing the company over to another generation, selling to a strategic buyer or partnering with a private equity firm, owners often face a decision between maximizing ROI or solidifying their legacy. Perhaps by selling to a strategic they can realize a return on the equity they have built over their career. However, this can typically leave family employees without the company they hoped to inherit and carry out the owner’s vision.
Every potential transaction presents it’s own benefits and pitfalls. Ironically, one of the most risky situations can be when you sell internally to a family member, co-founder, or group of employees. Although the approach seems safe (and most convenient), it holds significant potential downsides if executed haphazardly. Here are some topics to consider when selling internally:
Your returns. Presidents and CEOs sell their companies for different reasons, but they all share share one common goal: return on investment. You ran the company, took the risk, and grew it to this point – you deserve to be compensated. Often owners will prioritize their legacy and the continuation of their business over maximizing valuation. The option is common and noble, especially since you’ve built meaningful relationships with your employees and the management team, but letting emotions cloud your otherwise strong business sense can leave you with a raw deal. If you do decide to sell internally, you should first reach out to an industry banker in order to speak with strategic buyers and financial sponsors so you can gain context and insight into the value of your company relative to the broader market. That way you can make a good, unemotional choice to sell the company internally.
Their capital (or lack thereof). It seems so simple, by selling internally you’re putting your company in the hands of the people who know it best. They have been through everything with you and are primed to take the business to the next level. However, your employees probably don’t have enough capital to buy you out. One option is an Employee Stock Option Plan (ESOP), where your employees buy you out little by little over time. But most often you’d like to cash out faster, so the internal team will most likely need outside capital. In addition to commercial banks and community banks, it will often be critical for them to connect with other capital providers that you’ve been building relationships with over the years. Often PE groups and alternative sources of capital, like mezzanine and senior debt providers, are willing to work with the future owners of your company. New to the private markets, your internal acquirer could be backed by capital and outside partners that might not have your company’s longevity in mind. The solution here is to both ensure you already have long-term relationships with capital providers you can introduce to the team and work with the internal team to vet different capital sources in order to find the right partner for your future company.
Your liability. You sold the company and now leave it in the capable hands of your management team. You received full price for your shares and a considerable bonus on the exit – you’re out. Despite the exit you can still be held liable for outstanding loans that the company took under your leadership. Also, you (and the new owners) forgot to execute mutual releases so you’re still tied to their actions. No matter how well you know the people you are selling to and who is taking over your business, you should ensure you go through the necessary contracts and documents with your legal counsel to ensure a clean break for yourself, new management, and the future of the company.
Taking back a failing company. One of the common ways of selling to an internal party is by constructing a contract that pays you out, over time, with the profits from the company. It’s a slightly different construct from an ESOP and can work beautifully as long as the company continues to grow, but can become complex if the new owners fail. Since your payout is dependent on their execution, their failure could allow you to reclaim what is left of the company. But, do you really want to retake the now crumbling company in order to try to stem the failure? Ensure that in your effort to sell to internal partners, you don’t forget to price in the additional risk you’re taking by selling to them over time as opposed to getting a lump sum from an external buyer on the open market.
It’s convenient to think the process of selling internally will be a breeze and that is what makes it most dangerous. By selling internally, you should be hyper aware of these three things and who ultimately will be running (and financially backing) your company moving forward.