Selling to Employees: Is Your Exit Strategy Right in Front of You?

Posted on July 10, 2016 by John F. Dini

When I interview a prospective client for exit planning assistance, we usually explore selling to employees. The first reaction is always “That won’t work. They don’t have any money.”

If you have a company with reasonable cash flow, a talented management team and sufficient time, selling to employees is not only a realistic option; it may be the best way to get value from your business. I’ll define those parameters for you in a minute.

If you haven’t read my eBook Beating the Boomer Bust, follow the link for the free download. My research shows that the hard numbers will inevitably translate into a hard market. There are 3,000,000 Baby Boomers (over 50) who own businesses with employees. Over the next 20 years, that’s an average of 150,000 owner retirements per year. Intermediaries (brokers, private equity and M&A) account for about 9,000 transactions a year.

That leaves a lot of folks looking for a way to cash out. Selling to employees is a process that lets you keep control until retirement. By structuring the sale correctly, you can leave with the proceeds in the bank, not in a promissory note.

How does that work? It requires a bit of mental gymnastics. First, any owner has to accept that the only source of funding for any transaction is the cash flow of his or her company. If a buyer pays cash, he expects that cash flow to pay him back. If a bank finances the acquisition, they expect the cash flow to service the debt. If you finance it, you are the essentially the bank.

Selling to employees is the same. You use the current cash flow to help employees buy stock. In return, they qualify by working to increase the value of the business until your final return is equal to (or more than) what it was when you started.

Think of it as taking a note for 30% of the purchase price while you are still in control, so that you can get a 70% cash down payment when you leave.

Now, let’s discuss the parameters.

Cash Flow: Your company has to be earning more than just your paycheck. My rule of thumb is that around $500,000 a year after owner’s compensation gives enough to work with. More than that doesn’t change much, since then we are usually looking at a higher purchase price. Less than that is doable in a longer time frame, or if the owner is willing to subordinate some debt to the bank.

Management Team: You need at least one decision maker who does more than just go through the operational motions. Any third-party lender wants to be comfortable with company leadership when you’re gone. A large portion of our planning surrounds transfer and documentation of management capability sufficient to satisfy a lender.

Time Frame: Many business owners tell me “I’ll think about exiting in five years.” That’s fine, if your plan is to retire in fifteen years. Generally speaking, the longer you have, the more lucrative an internal sale can be. I’ve done three year plans, but five is much more comfortable, eight years is even better, and we regularly work on transitions of ten years and longer.

all for one one for allSelling to employees requires legal agreements, specialized compensation plans and a willingness to run the company transparently. The return is a team that is committed to the long term, highly motivated, and all on the same page when it comes to growing the business.

Why should you consider selling to employees?  Because your company lives on with the culture you created. Because you can choose the value, not negotiate it. Because your employees aren’t comparing your company with other investments. Because you control the timing of your exit.

Because it is probably the biggest financial transaction of your life.

Do you know an owner who would benefit from reading Awake at 2 o’clock? Please share!

Posted in Exit Planning, Exit Strategies | Tagged , , , , , , , , , , , , , , , , , | 1 Comment

One Response to Selling to Employees: Is Your Exit Strategy Right in Front of You?

  1. TKO Miller says:
    August 10, 2017 at 3:45 pm

    Great article, thanks for sharing. We\’ve also written a blog post on why 2017 is the perfect time for baby boomers to consider selling their businesses. Read it here: https://www.tkomiller.com/blog/baby-boomers-and-business-owners-2017-is-your-year

    Reply

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Employee Experience: Is Bigger Better?

Posted on July 3, 2016 by John F. Dini

Small businesses provide much of the initial employee experience. We take younger folks and teach them decent work habits like showing up every day, being on time, and working to deadlines.

As owners, our personal skills may not be sufficient. We can’t teach everything necessary to run a growing company. We turn to the outside for experienced employees, people who can bring what they learned elsewhere to our team.

In many cases, we are looking for someone who has performed at the next level, handling more people, more responsibility or higher level functions. Instead of helping someone grow into a job, we want someone who can help the company grow into what they can already do.

Often, those people come from much larger organizations. They may have run a department that was bigger than your whole company. We know that big corporations have a very different culture than small businesses. How can you determine whether a prospective key hire is going to be a fit for your business?

First, there is attitude. I’ve found many veterans of big business are condescending towards “little brother” businesses. They believe that their knowledge should be welcomed with unconditional acceptance, and that the way they learned to do it in BigCorp is the only way to do it.

Be careful of attitudes that indicate the prospect believes that having fewer subordinates or a smaller budget means less work. I’ve had candidates tell me that they wanted to move into small business because they wouldn’t have to work so hard. (!)

Resources drive the managerial employee experience in large organizations. You may not be able to throw personnel, marketing dollars or technology at a problem. Check for resource dependence by asking how the prospective hire would tackle a problem, then remove some of the resources and ask for another approach. They aren’t cut out for small business if they get that “deer in the headlights” look.

The biggest issue in qualifying employee experience from a larger organization is personal responsibility. In BigCorp missing budget means you don’t get a bonus, not that everyone doesn’t get a paycheck. Ask about times he or she failed to reach a goal, and the consequences.

zebrasIn large organizations you can hide in a crowd for a long time. Be wary of resumes that concentrate on credit for group activities. Carefully review claims from a member of an “award-winning team,” “record setting department,” or “nationally recognized initiative.” Such people may be superstars, or they might just be very skilled at standing next to superstars. Examine their personal contributions in detail.

A key employee who brings solid experience to your organization can be a huge boost towards the next level; but if he or she can’t walk the talk, it’s just an expensive drag on your whole company. Don’t get caught up in the halo effect of ‘Bigger is Better.”

Did you read something in Awake at 2 o’clock that would be relevant for a colleague? Please share it with other business owners.

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What’s in YOUR Nondisclosure Agreement?

Posted on June 26, 2016 by John F. Dini

A Nondisclosure Agreement (NDA) has become one of the basic standard documents in every company’s wallet. Between the rising swell of Baby Boomer owners entertaining exit planning, and greater caution surrounding the legal issues of strategic partnering, an NDA is now the standard next step following many initial exploratory conversations.

What should you protect in an NDA? (Note: I am not an attorney, and I don’t create Nondisclosure Agreements for clients.)

Secret informationFirst, there is the question of who is covered by the agreement. Most allow for advisors to each party to see the agreement. That can encompass accountants, attorneys, consultants, bankers and employees. I think employees present the greatest risk, since they are the most likely to personally benefit from information about customers, vendors and pricing.

Some attorneys include language requiring every person who shares the information to sign and return a separate copy. That is cumbersome, and opens the question of enforcement. If you talk to someone on the other side of the transaction, and don’t have a signed copy of the agreement first, have you voided that condition yourself?

Try to keep the responsibility for protecting information with the other side. One mechanism is to have each person who sees information add their signature to the agreement, with language that makes it the other party’s responsibility to only share with signatories. At a minimum, the other party should be required to make certain everyone on their side is informed of the confidential nature of the information. Electronically stamping everything “Confidential” and converting it into pdf is also a basic caution.

Then there are decisions about what information to share. Most potential acquirers are concerned about customer concentration in sales. They will ask for customer purchasing history as one of the first items in preliminary examination of your company.

That is a legitimate concern, but it doesn’t mean they need the names of the customers until much later in the process. We provide redacted reports, identifying customers by letters or numbers.

The same type of common sense applies to vendors, employee compensation and margins by product line. You can provide sufficient information for valuing the business without the details. No matter how honest or well intentioned the other party may be, he or she will remember that you are making 10% more on a specific product, or are selling substantial amounts to a customer they thought was all theirs.

Finally, we recommend that the Nondisclosure Agreement go beyond just keeping information confidential. It should always include a non-employment clause regarding your employees. Non-solicitation is okay, but it’s hard to prove if the company claims the employee approached them. Just make it simple; they can’t hire any employee for two years following your discussions. You may be surprised at how many potential partners balk at this condition.

Always have a qualified attorney draft any Nondisclosure Agreement, but there is no need to go wild. One page is typically insufficient, but more than two pages and you are usually loading it up with conditions that are either irrelevant or unenforceable.

No NDA will stop someone from being dishonest. It is intended to make plain what you consider yours, and how you expect it to be handled. As in any other business transaction, what’s written on the paper doesn’t replace trust.

 

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Posted in Entrepreneurship, Exit Planning | Tagged , , , , , , , , , , , , , | 5 Comments

5 Responses to What’s in YOUR Nondisclosure Agreement?

  1. Jim marshall says:
    June 26, 2016 at 9:41 am

    In some areas an NDA requirement preventing hiring any your employees have been found not legal because of is effect on freedom to find new employment for the employee. EG where there are limited opportunities for certain skill sets in the geographic area.

    Reply
  2. Richard Mowrey says:
    June 29, 2016 at 8:20 am

    In many areas, employees’ response to an open advertised employment solicitation is normally not covered by the NDA’s restrictive provisions….while direct contact is. From a client perspective, it is important to note the difference and that the risk exists, but is essentially the same as it is in “normal” times.

    Reply
    • John F. Dini says:
      June 29, 2016 at 12:33 pm

      Good point Richard. Actually most large companies won’t agree to a non-employment clause for just that reason. They don’t want liability (or screening responsibility) for normal recruiting activities. With smaller acquirers, JV and merger discussions, I have seen it included (subject to state unemployment law, as was previously noted.)

      Reply
  3. Ted Leverette says:
    October 29, 2019 at 1:43 am

    One of the biggest mistakes too many searchers/buyers make entering the buy/sell playing field is not getting their own NDA signed by brokers, owners and sellers of companies. (Not to mention some of the horrible NDAs foisted on searchers.)

    • What about protecting the fact that you want to buy a business . . . and you don’t want your employer to know about it?

    • How about the content of your financial statement and borrowing power?

    This is why the advisory teams of savvy buyers and sellers include experts with a proven record of facilitating win-win deals that should occur.

    • I, for example, won’t collaborate with buyers unless they hire the right kind of attorney and tax advisor at the right time and then properly engage those specialists. It’s good for all of us.

    BTW, it’s 2 a.m. right now at home in Florida and I’m awake reading John Dini’s excellent website (awakeat2oclock.com) while awaiting a call from someone I’m helping in the UK.

    • “Awake at 2 o’clock” . . . I wish I had thought of that title!!!!

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Choosing Not to Maximize Profits

Posted on June 19, 2016 by John F. Dini

The other day, a client asked me to review some questions from an MBA student studying business ownership. One of the questions was “Are you doing everything possible to maximize profits?”

profit maximizationI’ve seen the same question asked in a number of business assessments over the years, and it always struck me as silly. It’s one of those “gotcha” questions that any rational business owner can only answer in the negative. Who in their right mind could claim that he or she is doing everything possible to maximize profits?

Regardless of how many hours you work, you could conceivably work a few more. You could ride your employees a bit harder, or make do with one of two fewer.

You could pay lower wages, charge more for your services, or refuse to honor implied guarantees.

Reading the previous few sentences, I’m sure you are thinking “No I can’t. If I did that I wouldn’t have (customers, employees, a family) anymore!”

Right. We own businesses because we want to choose for ourselves. One of the choices we make every day is not to do everything possible to maximize profits.

Choosing Against Profit

We choose to replace a product that wasn’t satisfactory even though it performed exactly as promised.

We choose to go the extra mile for customers with service beyond what was originally agreed, because we want them to be happy.

We choose to offer decent wages, paid time off and benefits because we want productive employees who like their jobs.

We choose to take time with our families, even though there is always more work to be done, because we need to have balance in our lives.

In fact, the majority of decisions made by a business owner every day are about not maximizing profits. That’s our privilege.

Of course, profitability is the enabler that makes all those decisions possible. It’s the firm foundation that  gives you flexibility. It is not, however, the only reason you own a business.

So the next time someone asks if you are maximizing your profits, proudly answer “Absolutely not!”

Posted in Entrepreneurship, Management, Thoughts and Opinions | Tagged , , , , , , , , , , , , | 3 Comments

3 Responses to Choosing Not to Maximize Profits

  1. Ed Pratesi says:
    June 19, 2016 at 2:31 pm

    John,

    I agree with your premise, what the question should be is “Are you maximizing value?”

    The very choices made by business owners include many of the above that lead not to short term profits but “hopefully” sustainable value.

    Reply
  2. Frank Arnold says:
    June 20, 2016 at 5:57 am

    John,

    Well said and of course there is the issue of reinvesting in the business for sustaining and growing profits, but over the long haul.

    Reply
  3. Mario Ray says:
    May 25, 2020 at 3:44 pm

    I think that a good question is: Are you happy with your business?
    Then ask: What in your business would make you happier?
    Then, decide if you want to do it.

    Reply

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What the Heck is Exit Planning?

Posted on June 12, 2016 by John F. Dini

The wave of Baby Boomer retirements is beginning. I’ve been writing and speaking about exit planning nationally for the last ten years, (you can download my free eBook on the subject here), but the inevitability of the demographics is gaining momentum.

Today, Boomers in their late 60s are starting to sell the businesses they’ve built over the last 30 years or so. They are just the tip of the iceberg. Millions more are steadily approaching their career finish lines at a rate of hundreds every day.

Exit Planning is a new discipline, developed to meet a massive market need. Unfortunately, like any new service offering, there are a lot of people who use the term without fully understanding it, or in hopes that it will associate them with a growing field of professional practice.

Accountants say they do exit planning when they help clients structure their business and personal holdings to minimize the bite of the IRS.

Estate attorneys say they do exit planning when they protect assets and document transfers of inheritances.

Wealth managers say they do exit planning when they provide retirement projections and validate lifestyle assumptions.

Consultants say they do exit planning when they recommend ways to increase the value of the business, presumably maximizing the proceeds from a sale.

Business brokers say they do exit planning when they value and list a company for acquisition.

Insurance brokers say they do exit planning when they write policies to protect owners, their families  and their companies against premature departures, or the absence of key employees.

Which of these professionals really do exit planning? There are two answers:

  1. All of them
  2. None of them

Exit Planning Map MazeExit planning is the process of developing a business owner’s strategy for what may be the biggest financial transaction of his or her life…the transfer of the business. That strategy may be a succession to the next generation of family. It could be a sale to employees. It may be a sale to another entrepreneur, or acquisition by a larger company. In some cases, it could require an orderly dissolution.

In every case, it involves tax, legal, financial, operational and risk management expertise. No one practitioner (including me) has all the knowledge required for every aspect of the plan. Exit planning, in the true sense of the word, is coordinating all those skills so that they work together for a single objective.

Let’s say, for example, you run a warehouse with delivery services. You decide to make it as efficient as possible.

  • You tell the purchasing manager to only order product when pricing and inbound freight are the least expensive.
  • You tell the warehouse manager to develop a system for picking orders with methods that require the least amount of labor.
  • You tell the shipping department to pack up orders using the least possible amount of material.
  • You tell the dispatcher to plan routes for times with the least traffic and the lowest fuel use.
  • You tell the sales department to promise the customer anything that will close the sale.

Now, without letting any of these people talk to each other, you announce that tomorrow you are implementing all their results simultaneously. You go home dreaming about how amazingly profitable your business is about to become.

You don’t have to be a distribution expert to know what is going to happen. The uncoordinated plans are going to explode when combined. You’ve just come up with a great way to go out of business.

Now, what if you told one manager that your overall goal is to sell more product and give excellent service, so customers would become loyal buyers and the company will increase revenues and profits?  Then you had the other managers report to him, so that all of their plans would compliment the overall objective.

That’s what an exit planner does.

If you enjoy Awake at 2 o’clock, please share it with other business owners.

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One Response to What the Heck is Exit Planning?

  1. Cathy L. says:
    July 11, 2016 at 11:46 am

    John,
    Thanks, I have a small chocolate wholesale/retail business. I started 6 years ago and after growing from 3 part time employees and lots of self employment expenses, remakes etc. I have been just me myself and I. I work almost 24/7 and multi-tasking is the name of my game. Now, I am thinking of relocating out of state and downsizing because I love what I do, but to consult with my accounting person about planning for a closing of this business and starting the same business in a different state that I will eventually retire in. I feel I have learned what to do and what not to do, so I have about 1-2years to schedule the move.
    Thanks, always enjoy your posts..

    Reply

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