Business Succession Planning: Management Buy-Outs and Selling Shares to Employees
When the owner of a privately held business is looking to move on they will often approach a business broker and sell to an unknown third party; or perhaps they will contact others in their industry to see if a competitor wishes to buy them out. An alternative is to sell to someone already working in the business.
One option for a business owner is to sell their company to one of the business’ existing management team or other senior employees. If one or more of the managers or other senior employees buys the business, this is often referred to as a Management Buy-Out (MBO).
The advantage of an MBO is that the owner will be selling to people that they have confidence in. The buyer will most likely already have relationships with customers, suppliers and staff which can make the transition much smoother. Owners often build up a business over many years and genuinely care about their customers, staff and others that they have a business relationship with. The owner will most likely know the buyer well and have confidence that that person will know these parties and be able to continue to nurture and develop these existing relationships.
To make the transition to new ownership smoother, the current owner will often agree to provide support to the buyer, usually by contracting to provide services back to the company for a fixed period of time.
Share sale to employees
Another succession planning option is to sell just some of the shares in the company to an existing, usually senior employee, and for the owner to retain the majority of the shares in the company. Then over time the remainder of shares can be transferred to the buyer. The right to buy further shares can be based on financial or other targets being achieved by the purchaser, or the company as a whole.
An advantage of selling to an employee is bringing in someone, generally younger, with enthusiasm to run the business. They are then able to increase value of the business with new ideas and hard work and the existing owner benefits because they still hold the majority of the company’s shares.
Structuring the transaction to protect the owner’s interests
In either a full sale by MBO, or sale of only part of the company to an employee, it is possible for the owner to let the purchaser pay off the shares they have purchased over a period of time. This is referred to as “vendor finance” because the seller of the shares (the vendor) is effectively providing finance to the purchaser until the shares have been paid for in full. An advantage of vendor finance is that it can enable a purchaser who otherwise may not be able to afford to buy shares in the company (e.g., because they have recently financed a house purchase) to participate in the transaction.
Vendor finance is often provided in conjunction with some bank funding which enables the owner to receive a portion of the purchase price (the bank funded part) immediately at the time of the share sale.
When vendor finance is provided it is usual for the owner of the shares to take security over those shares until they have been fully paid for. This means if the purchaser of the shares were to default on their payments, the owner will have the ability to take back the shares. The security can then be registered on the Personal Property Securities Register to give the owner priority over subsequent secured parties.
If shares are sold to an employee and the owner is retaining an interest, it will be very important that a Shareholders’ Agreement is prepared to set out the rights and obligations of both parties. This may include things such as:
- matters that require approval of all shareholders;
- what happens if a shareholder gets sick or dies;
- how shares are to be valued;
- how share transfers are to be conducted;
- any restraints on a party who has sold their shares in the company;
- where the original owner is still a majority shareholder - a requirement for the employee to sell their shares back to the original owner if they leave the company within a certain period of time; and
- what is to happen in the event of a dispute.
It is very important that these types of succession planning transactions are structured correctly to protect the owner’s interests. We regularly work with business owners, accountants, bankers and other advisers to ensure such transactions are structured appropriately and to ensure the owner’s interests are well protected.