Are Your Employees the Best Possible Buyer of Your Business?
The following is a real situation with names and details altered for anonymity.
The business is struggling and the owner, who is not actively involved in the day-to-day management of the business, wants to get out of the business. He would like to sell the business, but valuations have come down and he wonders if he can get more cash from just closing the business and pocketing whatever cash is left.
Although some of the employees have interest in buying the business, the main issue (as it is in many buy/sell transactions) is the price they will pay. And this is where this scenario raises an interesting point.
The business is in an industry that has been very negatively impacted by our current recession. Within the next two months the company will have completed all of its work-in-progress and backlog, meaning there will be no more work for the company to perform after 60 days unless the company can secure new work in that time frame. The market for their work and product remains weak and may continue to be weak for the next 12 months or more.
The book value of the company is about $1,000,000, meaning when all liabilities are subtracted from all of the assets of the firm, the remaining value is about a million dollars. The EBITDA valuation method generates a value between $700,000 and $1,500,000 depending on which multiple is used. The Discounted Cash Flow (DCF) valuation comes in between $500,000 and $1,500,000 depending on the cash flows projected and the discount rate assigned to the model. It is interesting that some of the valuation models give ranges that fall below the current book value of the firm. This is likely a result of the struggles the company has suffered recently and that are projected into the coming years.
So, what is this business really worth to the employees? Instead of looking at these valuation scenarios, most of the employees are interested in buying the business so that they can keep their jobs. When faced with the prospects of the company closing down in a few months and their impending unemployment, the employees would rather try and come up with the cash and capital to buy the business and keep the business alive. Certainly their investment and continued employment are now at risk (because their savings/investment) was not at risk before, but they seem to be willing to take such a risk. Why?
The only logical reason would be that they feel that the business has some intrinsic value at or greater that the purchase price. Perhaps they have insights into the market and their prospects for more work. In this situation, the real reason is because unemployment is so high in this industry that these employees know they will most likely be employed for a long time. In fact, they are pretty confident it will take so long to find a job that they would burn through some, if not all, of their savings anyway.
This is a good company that has built a good reputation in the market among its customers, competitors, vendors, suppliers, and others. The company is also positioned well competitively and will continue to make the most of its opportunities because the management team is strong, knowledgeable, and experienced. The employees trust management, and management will represent the majority purchasing stake.
In this scenario, the employees are the best possible buyer for the business. There are no formal or sophisticated buyers in the market for this type of business and any other potential suitor would be interested in a fire-sale price, at best. And, after a buyout like that, most of the employees would likely lose their jobs, anyway. The seller can get the most value for the business as well as a comfort that the business can continue on while the buyers can retain their employment and potentially improve the earning potential of their investment into the business.
As one caveat, it would certainly be advisable for each of the employees to consider their overall diversification strategy for their assets. With capital invested into this business as well as the business being their primary, if not sole, source of income, it may begin to look like all of their eggs are in the same basket. Each employee should talk to their financial planner or advisor for further consideration.
Mr. Kaufman,
How about creating an ESOP? I know it’s difficult to get financing but if the employees put up some of the cash required, perhaps a local bank would make a secured loan. Also, the current owner might be willing to take back some of the purchase price in a subordinated note.
Julius Goldfinger
Julius’ idea about creating an ESOP is very insightful. ESOP companies have significant tax benefits that positively impact a company’s bottom line. The company’s management team and employee group evaluating the purchase should contact the National Center for Employee Ownership http://www.nceo.org. The NCEO is a private, nonprofit membership and research organization that serves as the leading source of accurate, unbiased information on employee stock ownership plans (ESOPs) and ownership culture. They are the main publisher and research source in the field, hold dozens of Webinars and in-person meetings annually, and provide services to thousands of members. Their Executive Director, Corey Rosen is one of the nation’s leading expert on ESOPs. Here is his contact information:
Corey Rosen
Executive Director
Cofounded NCEO in 1981
Email: CRosen@nceo.org
Phone: (510) 208-1314