Transitioning Ownership of a Business to a Key Employee
You have a key employee or family member interested in taking the reigns of the business. How can you make sure the transition of ownership goes smoothly and is successful? There are many strategies and tips to help with this process. But remember it takes time to train and build leadership skills. Below we discuss four steps to transitioning ownership in a business to a key employee. For additional questions, schedule a free consultation with Peak Business Valuation.
1. Added responsibilities
The first step to transitioning ownership is increasing the responsibilities of the individual buying the business. You want to make sure the employee can handle the reins and all the responsibilities that come with owning a business.
Signing an agreement to start the process can be helpful. The agreement can state what the process looks like, the anticipated timeframe, and the responsibilities of both the owner and the employee taking over.
Begin by giving them more important roles. This does not necessarily mean extra compensation, but a promise for increased ownership as the individual demonstrates success. You as the owner can then begin taking a step back from the operations. The individual buying the business can then show leadership skills with decision-making, maintaining profit and production levels, and building quality relationships with employees and clientele.
2. Increased Leadership
The next step is to consider adding the potential employee/buyer as an officer of the company, to the board of directors, or management team. This will allow you to still maintain control but add a level of ownership and responsibility for the company outcomes and production. Doing so will help build the acumen of the employee and increase their knowledge of all the aspects of running a small business. This step is also helpful in building the trust of the other employees.
3. Transfer a Minority Ownership Interest
This next phase is to transfer a minority ownership interest. This is often called a vesting phase under a vesting schedule. This is where you as the owner transfer equity ownership and voting rights to the employee under certain conditions over a certain period.
One way to structure this is by issuing a note. The employee receives the stock transfer with a note that purchases the stock with profits they will receive during the transfer. Essentially, this is seller financing with a small portion of ownership. Another option is to have the employee pay the initial purchase price in cash. Selling a minority interest, also makes it more affordable for the employee/potential owner. This gives the employee incentive and a vested interest in staying with the company and ensuring its success.
Be sure to clearly state the responsibilities of each party. This will help you work together and avoid overlap and duplicated effort. Including an end date can also be beneficial. Communicating often and consistently can help ease the transition.
4. Transfer a Majority Ownership Interest
The last and final step is to transfer a majority ownership interest to the employee. The employee/buyer and the owner will draft a purchase agreement. A purchase agreement details the price and terms of the employee buyout.
The purchase price for the company is often determined through an independent third party. Peak Business Valuation is a leading business appraiser in Utah. We primarily work with small to mid-sized companies. We love helping small business owners understand the value of their company when looking to sell.
The transaction structure can be similar to that of the minority ownership interest. Like seller financing, the owner receives a note with the promise that the employee/buyer will pay for the ownership interest with profits they make through owning stock in the business. Otherwise, the potential buyer can seek financing through an SBA loan or other sources. For more information see our blog on Financing a Business Purchase.
During this stage, you will want to take a step down completely from the day-to-day operations and let the new owner take control. Letting your company go is not always easy. You are going to want to step in and save the day. And you may still be emotionally attached. But be strong, let the new owner take responsibility for decision-making and the outcomes.
The new owner will have their own style and approach to running the company. As long as the company continues to make profits and be financially successful the transition is well on its way. Let the business evolve and the new owners take it onward and upward. While you may not be involved day-to-day, some strategic guidance and mentorship may still be needed.
Summary
Taking the time with transitioning ownership to a key employee can help ensure the continuation of the business and its success. The process for an employee buyout usually takes between three and seven years.
As you begin transitioning ownership, one of the most important parts is understanding what the business is worth. A valuation professional, like Peak Business Valuation, can help in determining the value of the stock and the fair market value of the company. Questions are always welcome. Please reach out by scheduling your free consultation below!
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