Selling a Small Business to Employees:
Employee Stock Ownership Plan vs. Individual Sale

Sell to 3rd Party / Sell To Employees / Asset Sale / Succession Plan / Dissolution

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EXECUTIVE SUMMARY

One popular option for business owners looking to move on from their businesses is to sell to employees. Whether you sell to an individual or group of employees, this option allows the business to carry on with those who know it well—and have invested in its success.

Do you have an employee or a group of employees that are interested in buying your business? This Guide explains options for doing so, including an Employee Stock Ownership Plan (ESOP) or selling to an individual employee.

Benefits of Selling Your Business to an Employee

You rely on your employees to make your business a success, and over time, they have developed institutional knowledge on different parts of the business. Some own key vendor or customer relationships, have a deep understanding of your products or service or know the ins and outs of the company financials. Without them, you would be lost, and oftentimes, they are like family.

If you are planning to exit your business and looking for a plan to do so, consider having an employee or group of employees buy the business. This can provide a near seamless transition, continuity for customers and vendors and gives you peace of mind that the new owners truly care about the success and longevity of the business.

Additionally, selling to an employee or group of employees eliminates the time and expense of marketing the business to potential buyers or business broker fees.

Not every business has an employee or group of employees that are capable or interested in buying the business. Taking this option into consideration is part of the process of developing an exit plan through ExitGuide.

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How to Sell Your Business to an Employee

Think Through the Potential Outcome Before Engaging

When selling a business to a 3rd party, there is a fair amount of preparation involved, and our guide Preparing To Sell A Small Business will help you understand the first steps to take. Preparing financial statements, documents and insights on the business are necessary for a buyer to get up to speed on your business in order to make a buying decision and set an offer price.

Maybe you have been approached by an employee that has expressed interest for “when the time is right” or maybe it is something you have been open about with your employees. In any case, it is wise to put some thought into the idea before approaching anyone. You want to engage in any such conversation with the intent of making it work—second guessing yourself after an initial conversation can impact your relationship with a dedicated employee or group of employees.

Ask yourself the following questions as part of your own thought process:

  • Are you seeking top dollar for the business? Is receiving cash up front a requirement?
  • How much time do you estimate needing to spend transitioning yourself out of the business?
  • Are you open to a payout that comes from proceeds generated by the business after you exit?
  • Is the employee a capable leader for the current team? Can they adjust to the new role?
  • If a group of employees, is there an obvious leader they would identify to take over?
  • What are the key strengths of the new owner? What are their challenges?
  • How do you anticipate key customers and vendors reacting to the change?
  • What can you do to help set the company up for success if this happens and are those reasonable actions you can take?

Engaging In the Conversation

If you decide this is a viable path forward, you should approach the employee or employees with the idea. Having a timeline (not a deadline) in mind will help frame the conversation and make it as realistic and possible. You may not get the reaction you expect if the employee(s) has not considered the idea of taking on the business. That’s okay. We all process things differently, and even an exciting opportunity may be daunting at first as there are many unknowns from their perspective.

Selling to One Employee or Management

If one employee or a small group of employees (often a management team) plan to buy the business, the transaction is not all that different from selling to a 3rd party. In this scenario, a group of employees will pool together their resources to purchase the assets and liabilities of the business. It is the group’s responsibility to come up with a structure that works for them and present an offer as an entity. If it is a single employee, they are simply representing themselves and presumably buying all of, or a controlling stake in, the business.

As discussed in our Preparing To Sell a Small Business guide, you will need to prepare financials and gather relevant documents just like you would for a 3rd party buyer. Providing a recent valuation from a neutral party like ExitGuide can help establish a baseline for discussions. It is relatively common that an employee or employees may not pay top dollar for your business, but that does not mean they are paying below market either. By not taking the business to market in an effort to get top dollar, you are likely gaining a smoother and potentially faster transaction and leaving a business in known hands. This is important if you structure some form of profit sharing our upside after you exit the business.

The employee or employees are advised to hire their own attorney to advise them on the purchase agreement. Using a single attorney, especially one that has worked with the business in the past, creates a conflict of interest by representing both the buyer and the seller.

Selling Your Small Business Through an Employee Stock Ownership Plan (ESOP)

An Employee Stock Ownership Plan (ESOP) is a way to transfer ownership of the business to a group of employees. With an ESOP, a group of employees, perhaps all employees, take an ownership stake in the company. To accomplish this, the business needs to set a value for the company and that establishes a share price. Each employee is purchasing a number of shares at the designated share price. There are different paths for employees to finance the sale including each contributing a portion of the cash toward the overall purchase price.

Financing Through a Bank

ESOPs are often financed through a bank or other financial institution. Think of it like buying a house or piece of property, the bank puts up the cash and the employees make regular payments on the loan. This is most convenient to the seller, since the owner gets the cash shortly after the sale closes and is effectively done.

Seller Financing

It is quite common that a seller may finance the sale (instead of a bank). To do this, the seller will have an attorney draft a note that outlines the terms of the loan, as well as a purchase agreement. A seller-financed approach removes the bank (and their fees), though an owner will still collect interest on the loan. The buyer and seller do have more flexibility on how to structure the note, whether a combination of cash, proceeds from the business or forms.

A seller-financed agreement will have many of the same terms of a loan agreement from a bank: the purchase price, amount of down payment, amount of the loan, interest rate of the loan, term of the loan as well as what the buyer is using as collateral.

As an owner, you have relationships with the employee(s) and may have more flexibility on the terms than a bank would consider offering. That said, it is common practice to ask the employee for a business plan that outlines how they plan to manage and grow the business. This is not a test; it is a way for you to understand the plan to generate the proceeds necessary to pay back the loan.

Trust and Codify

Selling your business to an employee or a group of employees can be a satisfying outcome for both the owner and employees. While there is likely a high level of trust from working closely together, it is important to follow the standard steps of this transaction just like you would if this were a 3rd party. Yes, there may be some flexibility on terms but, it is absolutely critical to ensure the buyer(s) review and understand the financials, you have a valuation on the business, a Purchase Agreement and if the deal is seller financed, a Note that outlines the payment terms and structure. Putting it in writing cannot prevent disagreements in the future but it does codify the most important terms in legally binding agreements.

ExitGuide provides guides to help owners understand important topics related to exiting their business. If you are just starting to think about what to do, check out our other guides or get a free assessment that presents potential options.

DON’T WAIT, PLAN YOUR EXIT WITH EXITGUIDE

Transitioning out of your own business can be confusing and emotional. You have invested a lot into your business and taking steps to exit is not easy, in fact, most owners have never been through the process. You do not have to “figure it out” on your own. ExitGuide helps owners from start to finish by answering basic questions about the process, helping you develop a plan specific to your circumstances and then connecting you with expert resources to guide you to a successful outcome.

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