Family businesses, which overwhelmingly comprise the vast majority of privately held businesses in the United States, are the economic backbone of the American economy. The goal for many of these companies is to continue to perpetuate for multiple generations.
An often-challenging issue for family business owners is when there are no family members interested in taking the enterprise to the next generation. How do business owners in situations like this assure the business can still continue and their employees remain employed?
It’s generally not easy. More often than not, non-family employees don’t have the financial means to buy a business or even part of a business. Additionally, it is common for an employee who is excellent at his or her job yet be not willing or capable of actually running the business. Even discussing the possibility with an employee can be delicate, as once the topic is broached there is a possibility that a valuable employee could become concerned that the business may soon be sold and start looking elsewhere for employment.
When the right situation presents itself, there can be solutions. The owner probably has a good approximation of the value of the business going forward; if not a formal valuation can be acquired. A promissory note could be set that includes language protecting the owner by giving the owner the ability to re-take the business due to lack of payments by the employee(s)/buyer(s). If everything goes smoothly, the original owner will receive ongoing financial reports and profits to help complete the buyout. Conversely, if the company struggles, the owner would have the ability to right the ship and once again take over the business.
When a family business isn’t being passed to family members, but rather transitioning to employee ownership it is critical that proper training and leadership is in place for the new owners.
An agreement can be implemented that states that during the process the pre-sales and sales process that the employee will be given more important roles but with the written promise that ownership will be transferred as they prove themselves with their growth and development. This proving period can have different levels of achievement such as maintaining profit levels and production quotas, maintaining morale with key employees or simply showing leadership skills with good decisions when the owner steps back a bit from operations.
It may also be helpful to name the potential employee(s)/ buyer(s) as an officer of the company or possibly adding them to the board. The original owner will still control the process and help position the potential new owner(s) by providing some ‘trial runs’ to make sure they are capable.
Once their abilities are proven, then the transferring of ownership can begin (with strings attached—also known as a vesting phase or vesting schedule.) At these points, real ownership and voting rights will transfer to the employee(s) under specific circumstances over a scheduled period of time. The purchases can be executed as stock transfers to the employees to start the payoff.
Another school of thought is the transferring of a majority of equity ownership through non-voting stock which will allow the owner to maintain control by owning the majority of the voting interest while selling the equity or profit interest that’s funding the buyout. It’s prudent for the business owner to protect themselves during transition.
Lastly, it takes discipline as the owner to have a ‘hands off’ mindset. It may not be easy to not step in and fix something during the transition. You’ll maybe bristle at the way certain decisions are being made by the ‘new’ owners but the process has to run the course. This may be accepting a new style but as long as the company is profitable and humming along, step back. Remember that you started this transition to keep the company going while acquiring financial freedom and flexibility during retirement.