Carl Gerhardt
Editor’s Note: This is the second in a series of four articles about exit strategies for small business owners.
In Part one, I discussed how the old Chinese proverb “He who rides tiger must find way to dismount” relates to any business. In other words, how owners can dismount or exit the tiger of a business they have founded and ridden successfully for many years. This article will explore how selling your business to a family member, employee, or another individual you know who has the industry experience, skills, and desire, can be an effective way to dismount.
There are several advantages to selling your business to someone that has been groomed to take it over. By planning months or years in advance, the employee or family member can gradually assume authority and learn various aspects of the business that are necessary for success. During the planning stages, testing the candidate’s ability to lead employees and relate to them is a critical element of attaining future success. The same can be said for maintaining strong customer relationships to ensure against any loss of business in the transition.
Moreover, selling to a member of the pride can benefit the owner financially, permitting a full price sale and a built-in “annuity.” Almost always, this type of sale will require a major portion, or even 100 percent, financing of the sale price. Although this may be viewed as a disadvantage, as will be discussed later, I don’t view it that way. If the business is positioned for success with a well-groomed employee or family member, the risk of keeping the money in the business and taking payments over time may be a sound investment with good returns.
Another benefit of this method of sale is that it ensures stability for the current employees and customers, which is something very important to many owners. Strong ties and friendships often evolve over time with employees and customers that many of us want to protect as much as possible in a sale. The seller can continue to maintain a strong degree of control over the major decisions affecting the business. This can even include voting control of stock until financing is paid off, if necessary.
Selling the business to someone you personally know and trust can keep the business positioned for success before, during, and after the dismounting process. A common attitude among sellers is that they want to “milk the business” for years prior to the sale and then dump it to an unsuspecting buyer. In return the buyer will end up with a printing business so far behind the power curve that it will be difficult to save, let alone position for future success
Today’s market and competitive factors require constant reinvestment in technology, equipment, employees, and marketing. Despite the obvious financial requirements, this can be positive if viewed properly. The opportunity has never been greater for those who are willing and able to capitalize on the shifts in the market. Basically, you must run your business like you never intend to sell it if you want value for the new owner—and it must have value for the new owner.
One of the largest drawbacks to selling to an employee or family member is that they are most likely not going to have much, if any, capital to pay a substantial portion of the selling price. Certainly, it is best if they have “some skin in the game.” They can possibly come up with capital from home equity or personal savings and, if the buyer is an employee, their family members may be able to offer assistance. As another financing option, a buyer can use the assets of the business (if they are paid off) as collateral for a portion of the sale price. Regardless, I do not consider this to be all that important an issue if the sale is to the right person who can take the business forward. Even with the sale to a third party or a competitor, seller financing is most often required for a portion of the sale price of any small business.
Another issue critical to success in this type of sale is being objective about the person or persons buying the business. This is most difficult with family members, but there may be similar problems with key local employees. Do they really have the skills and “fire in the gut” to deal with ownership? You may not know until you really turn over the reins.
This is very difficult for most owners to do gradually. As the longtime boss, it is hard to back away and let the new owner run it their own way. A great way to transition them into ownership is to first appoint them as general manager and to exit the day-to-day operations or retire part time. If this proves to be unsuccessful, step back in until you find the right person.
Certainly you should attempt to use the resources of a good HR consultant, to evaluate candidates before you begin the process. It’s worth the time to try with more than one employee/family member if necessary. I sold my printing company to a key employee, but it took me three times to find the right person.
Here are some other things to consider in selling to a member of the pride. If you have a family member in the business, it is important to consider the implications for the family. It may not be worth upsetting other family members or even your marriage if you can’t work out the who, why, and how of selling to a member of the pride.
Also, it is important to sell the business directly to “one” person. Often owners have a bias toward wanting to sell to all of his or her employees. This can be a sure ticket to failure. It might be acceptable to sell to two or three key employees, but even that can be prone to risk. If you decide to sell to more than one person, you should have one individual as the majority stakeholder who has operational control of key decisions.
Lastly, don’t tie the hands of the buyer(s). Making it difficult for them to make decisions can create paralysis of the business. I have seen owners who require that no additional investments are made in the business until their loan is paid off. This can result in failure, especially in today’s fast-changing environment. It is important to maintain some control, but not force a situation that prohibits sound decision making.
In conclusion, I admit that I have some personal bias in favor of selling to a member of the pride versus to a third party. I did not have a family member who wanted to enter the business, but through luck and my wife’s great intuition, we found a bright young man and made him our exit strategy. He had the passion to own his own business from the start. He operated as a “hands on employee” for two weeks until he found his own replacement and then progressed through the ranks of customer service and eventually into a position as general manager. We started a “sweat equity program” in his second year and gradually sold him the business over a 15-year period. The transition was completed in 2003 and within five years he grew the business 50 percent in sales and profitability and paid us off early, which has proven to be a successful dismount for my wife and me.
Carl Gerhardt is retired chairman of Alliance Franchise Brands. He currently volunteers as a SCORE mentor/consultant to small business. His services are free of charge to his clients. He can be reached at cgerhardt@frannet.com.
