Ensuring the sustainability of an entrepreneur’s departure thanks to key employee shareholding | Schwabe, Williamson and Wyatt PC
Business succession planning for private business founders can take several paths. One of the most common exit plans is transfer of ownership to management or key employees and it’s easy to see why: Transfer of ownership to key employees creates shared goals based on values and can empower owners enough time to make their exit. There are many ways to make this transfer, such as long-term installment sales, leveraged business buyouts, employee share ownership plans (ESOPs), and modified buybacks. This article only talks about some modified buyouts and the sale of the business over time. To help understand this type of business succession planning, this article uses a hypothetical technology company called Tech Co. to illustrate the following techniques and information.
One of the main questions encountered in succession planning is how to properly motivate future leaders of the company to continue the legacy created by the founder, which makes transfers of ownership to key employees so appealing. Key employees who will eventually become owners are as interested as founders in creating value, training future owners, and making the business more profitable, stable and better run. Employees who have been with the company for years are more likely to maintain the culture, heritage and mission of the company, as well as investment in the community.
The transfer of ownership of a business to key employees may be more gradual than selling to a third party or using other transition techniques. Once a founder embarks on this exit route, he or she can phase out the business over a period of perhaps five to ten years, while still earning income and maintaining control. This is particularly important because it allows key employees to gain experience in running the business without the permanent presence of a founder. It may also allow the use of certain tax deductible payments from the company to the founder.
Example: Tech Co. has a Founder and several employees, two of whom have been with Tech Co. for many years. The founder considers these two employees essential to the success of Tech Co. and wants them to lead the company one day. After confirming that both employees wanted a greater role within the company, the founder began to gradually prepare them for ownership, including including the two employees in her decision-making process for the company and by inviting them to participate in important meetings. This allows the founder to confirm that both employees are prequalified to lead Tech Co. through on-the-job training and observation. She knows their abilities and their dedication to the values of the company. These key employees are motivated to stay and grow the business, just like the founder.
Ultimately, the gradual transfer of ownership to key employees of a company allows a founder to separate ownership interests from control and governance of the company while being more likely to keep the company in the business. community, preserve employee culture and maintain relationships with customers and suppliers. continuous, so there is little or no disturbance. There are two common methods founders use to transfer ownership to key employees: (1) selling equity (or granting equity and therefore diluting the founder) and (2) donating the owner or donating them. company equity bonus.
1. Sell equity
Of the two common transfer methods, selling shares is generally the more popular option. This can take the form of the founder of the company selling his equity to key employees, usually with a first cash redemption, the rest being paid over time with a promissory note. It can also happen when employees buy equity directly from the business and dilute ownership. There are also many other ways to sell company stock that are not covered in this article.
Example: The founder of Tech Co. decided to make the two employees co-owners of the company. She is the sole owner and wishes to sell each of the employees 5% of her capital, making her 90% of the owners. The founder and employees agree that employees must pay 20% of the purchase price up front, with the remainder paid for by promissory note. The founder asks the company’s lawyer to prepare the necessary agreements and structure the promissory notes so that, ideally, employees can use their estimated future property distributions to repay the promissory note over the course of the period. time. The founder plans to continue transferring small amounts of her property to the two employees each year. If, before the transfer is complete, the Founder decides to postpone her release date or even sell to a third party, she now has motivated employees on board, which can help Tech Co. continue to thrive.
2. Donation or bonus of shares or issue options
Equity in giving is a popular option when key employees are family members as well. Typically, a founder will offer a child or other family member a certain percentage of ownership, often starting with 10 or 20% ownership and then gradually offering more over time. The fairness of donations can be an issue for tax purposes and for donation tax exemption purposes, so it is important to consult a tax professional before attempting.
The equity bonus typically occurs through employee stock options, a common form of stock compensation, especially among startups and tech companies. However, other equity such as restricted stock awards and other units may also be used. An employee stock option is an agreement that gives employees the right to purchase a specific number of company shares at a specified price, within a specified time frame. Although tax laws and securities laws impose some of the rules that govern stock issues and options, others are at the discretion of the company. Using employee stock options as an exit strategy can be complex due to the nature of these plans, so it is important to consult a legal professional before implementing them.
Example: After considering all of her alternatives, the founder of Tech Co. finally decided to continue selling her shares directly to the two key employees. At the end of each fiscal year, the founder continued to sell 10% of her shares until she no longer had a controlling stake in Tech Co. As she slowly sold her shares to the two key employees, the Founder was able to control her exit from the business, while ensuring that key employees would be able to maintain the corporate culture, maintain existing relationships with customers and suppliers, and minimize disruption.
Business succession is a long-term process filled with challenges, even unexpected opportunities, and careful planning and periodic review is essential. Selling your business to a key employee can be one of the most rewarding routes to a successful exit from your business. If either of these methods is used, other protections, such as employment contracts and shareholder agreements, are needed. To determine if this is the right exit strategy for your business, you should consult a legal professional.