I want to sell my company in stages to my employee? How do I go about this?
You will need to give some consideration to a dynamic price formula. The pricing mechanism has to work for now, and also into the future as you sell more shares. The price formula is the most critical part of the equation, and ideally it shouldn’t be too complicated. From the seller’s perspective, it is important to get a fair return. From the purchaser’s perspective, the opportunity must stack up, and it must be financially viable. And from the company’s perspective, the formula must be right so that the business continues to do well.
It is important to identify the true stakeholders. Ensure that your employee’s spouse or partner is on board. We often find it is useful to arrange an informal meeting with a purchasing ‘couple’ early in the process. This helps identify all their expectations and it allows an opportunity to talk through ‘fears’. Early meetings can build trust and help purchasers get their heads around the basic ‘give and take’ of what is on offer. Often financial risk is a part of the deal that they don’t like, but need help accepting. Talking about the risks helps. Another potential stakeholder is the purchaser’s bank, especially if it is expected that the last tranche of shares will be sold for cash. Mostly the bank will not confirm in advance exactly what it will finance in the future. However, a good discussion with a commercial banker will clarify the kinds of parameters that are likely to apply.
When the parties start to agree in principle, it is a good idea to write the deal up. We will often use a ‘Memorandum of Understanding’. This is a simplified non-binding record of where the parties have got to and what they envisage agreeing to. No legal commitment is usually expected until the purchaser signs a detailed agreement, and until they have a chance to consider the final agreement with their lawyer. Having a non-binding record in the meantime means that if a party wants to change their mind down the track, then they at least have to be transparent about it. These early write ups help bed in expectations. They also help contain costs. It’s better to identify issues at an early stage, than to wait till a prospective deal has been fully documented.
Consider dipping a toe in the water before you make a fully-fledged commitment. A provisional sale of shares may be able to be unwound for a time, at the same price, if the arrangement does not work out. Probationary arrangements allow the vendor to wait and see how the purchaser is adapting to a new set of expectations.
The Shareholders’ Agreement must be dynamic. As more shares are sold, the vendor will lose some degree of voting influence. The tipping point has to be managed carefully, so that the outgoing shareholder does not give up too much influence too soon.
When you offer shares to an employee, look at the total package. You will need to work out how the new arrangement will affect the employment agreement. What more will you expect from this person? What will they expect? If you are going to agree to ‘market remuneration’, always research and discuss what that means.