Ask any business owner whether he takes vacations longer than a week and you’ll get some insight into the depth of his management team.  Most businesses can’t operate very effectively if the owner is not overseeing operations on a daily basis.  This over reliance on the owner not only imposes additional pressure on the owner but also depresses the company’s value.  A key person discount is commonly applied in valuing a company that depends heavily upon an owner/operator.  If the owner is so valuable as to be irreplaceable the company might not even be transferable. 

Building a strong management team capable of operating the company without the owner should be a high priority for owners interested in selling.  Buyers aren’t interested in businesses that will flounder without the departing owner.  And even when buyers can replace the owner/operator, they generally pay more for businesses with experienced key employees. 

Let me caution you, however, before you conclude that a strong management team will always make your business more marketable.  Key employees often want to be owners, expecting to be given an opportunity to buy before the owner pursues other buyers.  By ignoring them altogether and selling to an outsider, the owner risks losing the management team and, perhaps, the sale itself.  Even more dangerous may be engaging in management buyout discussions that eventually break down, with one side claiming that the other side is unreasonable.  The real nightmare, though, is when key employees band together and threaten to set up a competing business, forcing the owner to choose between continuing without key employees and facing a new competitor or selling out to those key employees at a bargain price and with generous payment terms. 

Clearly, there is no problem with key employees if the owner simply sells the business to them.  Trouble is, most employees don’t have the cash necessary to complete the acquisition.  Bank financing may be available for a portion of the purchase price that can be secured by hard assets, but a significant equity infusion is needed if employees are to purchase the company on payment terms comparable to those offered by other buyers.  Owners selling to third parties rarely finance more than 1/3 to ½ of the purchase price, and payments are typically spread over five to seven years.  Without assistance from private equity groups, employees typically have to spread their payments over a 15-year period, too long for most owners.

To avoid problems with key employees regarding ownership succession, an owner should start by determining the value of his business and the availability of outside financing.  He should also assess whether there is a reasonable chance that employees will be able to consummate the purchase upon acceptable terms.  If a sale to employees is conceivable, an outside advisor such as an attorney, investment banker or CPA should lead the negotiations, providing an important buffer between the owner and his employees.  Instead of inviting the employees to go on a fishing expedition, the owner will fare better if he sets a the price and terms and uses his advisor to present the details of the plan, complete with after-tax cash flow proformas showing how the business will service the debt.  Before dismissing a management buyout altogether, an owner should consider other ownership succession options such as stock bonus plans that enable key employees to earn stock based upon the performance of the company.  To those employees who expect to be offered the business but are incapable of consummating a purchase, the owner should explain why he has decided to sell to an outsider and hope that they will understand his decision.  As for those employees who leave the company, an owner will be well served to have employment agreements in place that restrict them from competing against the company.

Despite the challenges, a strong management team significantly improves an owner’s chances of transferring a business.  But remember; if there is a transfer of your business, be sure you are the one initiating the transfer not your employees.

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