Most small to mid-sized businesses have a common challenge: Can we sell our business and get fair market value? An interesting consideration is an option which is widely overlooked, the employee-owned exit.
Selling one’s company to employees by way of an employee stock ownership plan, a.k.a., an ESOP, can result in a fairer market-rate valuation, preserve the culture, and share equity with employees while giving owners a way to create liquidity.
Can you sell your business at a fair market rate?
Business owners who desire to sell their businesses and get fair market value are founded by an owner (or owners) who perceived a market opportunity. The owner created a new business to solve the issue, scaled it, and now has a team of employees that are collectively working toward collective business goals.
Unfortunately, many business owners regularly make the assumption that they have built a company that is sellable. They presume, in the future, a decision to sell will readily aid them to monetize the company’s equity.
Who can blame them? Business media headlines regularly feature exits from large and sexy companies. If these companies can sell for 6X revenue (or more) and never turn a profit, an expectation is created that this unicorn-effect holds true for small companies.
Unfortunately, this is not typical. What is typical is for an entrepreneur to start a company, build it for 5-10 years, and to receive several offers for mergers or acquisitions along the way. These offers are typically not ideal and require the owner to participate in a heavy earn-out, and hit aggressive performance criteria down the road.
Acquisition expectations and realities
If, for example, you started a marketing agency, and along the way, you expected to receive purchase offers. The following situation is fairly typical:
Over five to seven years, the agency builds a staff of 15, a client base of 40-50 clients, and a $2M revenue stream. The agency generates approximately $300 – 400k per annum, and while stressful, provides a good income to all involved.
An acquirer approaches the owner(s), conducts due diligence, and ultimately makes an offer for $1.4M, or 0.7X revenue. This is quite a contrast from the exit multiples reported in mainstream business media outlets, and thus the lesson is that acquisition outliers dominate the headlines. The typical acquisition isn’t written about, as it is not glamorous.
The first lesson learned here is a company (particularly with less than $10M in revenue) is generally worth what an acquirer is willing to pay. It’s rare to receive multiple offers simultaneously, and comparable sales are not always accepted by those making an offer. Second, supply and demand will favor the acquirer. If you are not interested in an offer, it’s likely another small to mid-sized company will be, and acquirers know this.
Acquisitions are not without challenges
Upon acquisition, an acquirer is immediately going to reduce redundancies (this means some layoffs will occur), and your culture will change overnight to mimic the acquiring company’s culture. This could be good or bad, depending on how the two cultures mesh. In a typical acquisition, though, a portion of the staff from the company being acquired will choose to leave, making turnover an additional component to manage.
Considering an employee stock ownership plan (ESOP)
An interesting consideration to all of this is the employee-owned exit. Selling one’s company to employees by way of an employee stock ownership plan (ESOP) can result in a fairer market-rate valuation, and can preserve the culture and share equity with employees, while also giving owners a way to create liquidity.
Selling to employees is generally deemed as less risky than selling to a third party. This risk reduction can transform the exit of the $2M in revenue marketing agency selling for $1.4M and increase it as high as threefold, to nearly or just above $4M.
While owners may not see the Silicon Valley exit multiples of 4-6X revenue, getting 2X+ is much better than 0.7X.
How do ESOPs work?
In summary, ESOPs enable owners to obtain fair market value liquidity for shares by selling these shares to employees. Banks will often underwrite the transaction, enabling partial liquidity at closing. Employees begin to vest as owners are paid off, and can redeem shares at future dates for cash in hand.
Learn more about how ESOPs work at Legacy Press Ventures.
Jack Ogilvie is a founding member of Legacy Press Ventures. After selling his previous company, Techwood Consulting, to an ESOP, Jack co-founded Legacy Press to help others do the same. You can learn more about his company by visiting esopLPV.com.