[EP 311] Selling to Your Employees: The Mistake Business Owners Keep Making

Note: this transcript was generated automatically, so it will contain errors. It’s here as an easy way to scan for anything relevant to you, not as a word-perfect record of the episode.

Announcer (0:00): Ladies and gentlemen, are you ready?

Announcer (0:03): Okay, here we go.

Announcer (0:04): You’re listening to The Deal Room Podcast. Join us as we bring you the inside scoop on business sales and acquisitions. Get across trends in the area and hear the industry’s best recount their real life tips, traps, and experiences. Now, here’s your host, Joanna Oakey.

Joanna Oakey (0:24): Hi, it’s Joanna Oakey here and welcome back to The Deal Room Podcast, a podcast proudly brought to you by our commercial legal practice, Aspect Legal. Now, in this episode, part two of our two-part series, we continue the conversation with Brett Goodyer from Business Valuations Online, moving from part one where we focused on restructuring and exit readiness to part two, where we focus on a shifted area. We now focus on employee buy-ins, ownership transitions, and how these arrangements are structured in practice. With more than 30 years experience in valuations and forensic accounting, Brett brings to us a practical no-nonsense lens to how these arrangements play out in the real world, particularly where things haven’t been structured properly from the start. And in this episode, he and I together explore how employee buy-ins and internal succession pathways are typically structured, the risks and unintended consequences when they’re not planned properly, and of course, a few real world examples of where things have gone wrong and how they could have been avoided. So let’s jump into part two of our two-part series on The Deal Room Podcast.

Brett Goodyer (1:45): Okay, so employee buy-ins, I think I’ve only got 13 minutes. So I’ll try and do this in five in case there’s any questions. But I guess, look, this area is perhaps a little bit more obvious in that, maybe not. Like I think, number one, the issue with employee buy-ins, the first issue is structure. So it relates to everything we just talked about in restructure because there are, many forms from a structure perspective.

Brett Goodyer (2:24): That we see our clients in that means that they’re not optimally structured to be able to even deal with an employee buying. So, that’s the first thing. But I guess the thing is, as part of your annual review, we’ve talked about talking about the future, what the future looks like. But when we’ve got clients who are succession planning, when we’ve got clients who are thinking of potentially bringing employees on board, or if we’ve got clients who we suspect might be on the verge of burnout, this concept of helping them think about the opportunity of employee buy-ins becomes very relevant. So, what do we need to think about? So, there are things for you to think about, I guess, as you do in your annual reviews. But the sorts of things that need to be decided if there’s a decision that employees are potentially going to be given the opportunity to buy-in.

Brett Goodyer (3:21): First starts with valuation, obviously. Once again, very luckily, we all know someone who’s fabulous at that. But the reason valuation should seem obvious, but the reason I really wanted to call it out is because it can be.

Brett Goodyer (3:35): A point of particular discomfort for the seller in looking at this area because they get caught in this whole, they don’t know what that value should look like for an employee buying in and how to drive that discussion? And really the answer is having a clear valuation done on the business is my personal perspective. So it’s really easy for them to point to an objective document that’s sitting there that talks to the value. So that’s the first thing because there is a discussion or a communication path that needs to be thought about and valuation is part of that communication part. The next thing is ultimately right now is your client, a seller, a founder looking at selling all the shares right now but to employees quite often or almost always the way it happens is a partial sale now, with further sales to happen into the future. So that brings us to our third element which is okay how is this going to be structured in terms of payment. So, is it a staged sale? So, are we making a decision right now about the time and the dollars for future sales or will it be paid over time?

Brett Goodyer (4:51): Oh, sorry, will it be paid over time and will it be sold over time? If it’s paid over time, we call that vendor finance. They get the bundle of shares that they’re talking about right now, but it’s financed and we have to make sure that’s lined up properly for the seller. And there’s some things to think about there in terms of security to make sure it’s paid and how all of that will work. If the shares themselves are going to be potentially sold over time, then we have to work out how the mechanics of that will work. And often we’ll sit that in a sale agreement that might be options for the future, it might be put or call options, or it might be a staged sale where we set it all up in advance. So, there’s quite a few things to think about and to make sure we’ve gotten right in the way that sale is structured.

Brett Goodyer (5:40): Almost always, if we’re selling to employees, we want it to be a share sale. Of course, if we’re operating out of a unit trust, it could be a unit sale. I see that so rarely these days. So, really, mostly we’re talking about unit sales, sorry, share sales, share sales. So, we need a share sale agreement, we need an agreement, or we might have a subscription agreement, and here’s where we need to make the decision about whether we’re selling the shares in order for the seller to get the funds, or are we using a subscription agreement so we’re issuing shares for the funding to come into the company. So, usually it’d be a share sale, not a subscription, but we have to work that out along the way. And then we need a shareholders agreement to govern decision making.

Brett Goodyer (6:28): And really importantly, the seller’s ability to force a buyback if the employee leaves or if the relationship breaks down, and to deal with the ultimate exit of the founder if they want to, this is part of their exit plan along the way. And we do that by drag-along clauses. So that’s where the majority holder has the right to be able to force the minority to sell as part of the sale. And also we do it through options. They’re sort of our two key ways that we deal with this. Now, I just want to say a quick thing. I’ve got a few more slides. I probably don’t have time to get into the detail of them. But the one thing I just really want to point out here is the absolute importance of a shareholders agreement and thinking about the ultimate exit of your client as the seller, if you’re acting for the seller, the employer. If you’re acting for the employee, then there’s slightly different things to think about. But if you’re acting for the employer and.

Brett Goodyer (7:28): They have voiced a desire to sell to employees, then you need to ensure that whoever the lawyers are who are working with them have really clearly worked them through how to ultimately get out, because we have so many matters that come to us where there are issues at sale because there’s no clear shareholders agreement in play that enables a forced sale if one of the parties doesn’t want to sell. And that is very restrictive if we’re dealing with a seller who ultimately wants to get out of the whole company. So these are things that have to be thought about right at this point of the sale and have to be dealt with and built into the documentation, because the risk is, and this is what happens time and time again, sellers think about this, or the accountants think about it, or maybe you’ve gone to a lawyer and they’ve thought about it, but no one’s made sure that this has actually been seen through to the conclusion for inclusion in the shareholders agreement and it’s signed off. I can’t tell you the number of times we’ve had disputes come to us with shareholders agreements that have been drafted but never finalised and signed. So this is a critical area where we need to make sure we’re engaging in a process where the process ensures that all the documents are being signed off and it’s all being finished at the end.

Brett Goodyer (8:54): I would love you to throw onto chat, but just throw a yes here if you have ever seen your clients have an issue because they haven’t had the right shareholders agreement in place. They either haven’t had it signed, haven’t got one, or it didn’t have the right terms in it. So, just throw a yes if that has ever happened to you. And just to check whether people are actually responding, say no if you’ve never, ever met a client that has had a shareholders agreement issue.

Speaker 2 (9:21): And then in my forensic accounting hat now, I can tell you at least 10 different times that I’ve had to provide a report in a matter where there was not a shareholders agreement in place, and I was party to the litigation that fell out of it. And if it’s ended up in litigation, then we’ve already fallen over at various steps in between, because it’s quite a costly mistake to make, especially this drag-along, tag-along rights that we were talking about. They can completely hamper or destroy potential life-changing exits for some people, because essentially the purchaser is not interested in having a minority shareholder sitting in the background. They want complete control and they want the small shareholder to exit at the same time. So, yeah, quite problematic.

Brett Goodyer (10:23): Yeah, well, I literally had this conversation with a business broker yesterday with a matter.

Brett Goodyer (10:31): That is in their books with this sale, like an amazing sale price, a fabulous buyer, but only one party wants to sell, not the other. And where does that leave that other party when they don’t have any, you know, agreement in place? And the answer is it leaves them in a difficult and expensive position if they don’t have a clear agreement creating the mechanism for them to deal with that sort of issue. So, I guess this call-out is actually far broader than just thinking about shareholders or making sure someone’s looking at shareholders agreements in the context of an employee buy-in. It’s actually shareholders agreements in the context of any of your clients who have partners in the business. It’s just making sure that they have that shareholders agreement in place, should be a question maybe in your annual review, have they got a shareholders agreement in place, have they reviewed it in the last couple of decades, so.

Brett Goodyer (11:27): Because things change in the business, you know, sometimes these shareholders agreements once were relevant, not so relevant now. Okay, so we’ve only got a couple of minutes, I’m not going to go through any more of these details. But just, I think the key thing here to be aware of is there’s lots of moving parts. Shareholders agreement really important, but it’s just about making sure we don’t rely on handshake deals. We get really clear on any payment and repayment plans, because quite often that is a component of a friendly sale that we see in an employee buy-in situation.

Brett Goodyer (12:06): And just making sure someone’s on it who’s made sure we’ve got a shareholders agreement with the right exit, drag-along, tag-along, buy-back provisions, those sorts of things. And, I guess the one last thing I’d say here is what do you need, where do the lawyers fit in? What are they doing? So early stage before the deal, we have NDAs before we, you know, we’ll get a valuation in place, but we don’t want to probably give our employees that valuation and the financials in the business until they’ve signed an NDA. And then once they’ve agreed on terms, there should be a term sheet just to have the high level terms set out. And then after that, there might need to be, or before actually, ideally before all of that, we’ve restructured the business if we need to, to ensure that it’s restructured in a way that we can actually have a buy-in by an employee. So, the mid-stage is we’ve got valuation confirmation, we’ve got the actual agreement that deals with the sale, usually a share sale, we have a vendor finance agreement in place if applicable and security.

Brett Goodyer (13:14): And we have a shareholders agreement, and then right at the end, we’ve just got a checklist, making sure all of these steps have been followed, employment agreements have been updated, and all of that governance side signed off on. And of course, we’ve got a package to help if you want it, which includes a questionnaire and tailored agreements and things just to try and make it really simple for you.

Brett Goodyer (13:39): But this is not about me, this is more about you. So if you want to use the last one minute, anyone got any questions they want me to answer? Oh, by the way, I’ve got a book, I talked about it before.

Brett Goodyer (13:55): Here’s a code if you would like a discount for that book, we’ll send you a very discounted book. And the one last thing is I just want to say, we give free consultations for you, for your clients, whoever uses this as a sounding board, we want to help. But just one thing I wanted to talk about, sneak peek, we do heaps of AI workshops. So if you’re interested in AI in accounting practices or business brokerage, just let us know and we can let you know about some of those AI things that we are running. That’s it. Any questions?

Speaker 2 (14:30): That was impressive, bang on one o’clock. You sped up massively there at the end, but still very impressed indeed. Thank you very much for coming along, and sorry for the slight stuff-up in the initial stages of this webinar today. Thank you very much for coming along and talking to everybody today, really appreciate it, and appreciate all the little deals and tips and everything you’ve given us. We’ll send out this presentation to our attendees today, there’ll be a recording, and you’ll get your CPD certificate as well in emails over the next day or two. So I think that was about it. If you’d like it, if you head to businessvaluations.online, we will always help you with your valuations. But also, if you are interested in signing up for BBO Pro, our software for valuation professionals, by all means head over to bbopro.online, and you’ll get two months free use of that.

Speaker 2 (15:43): If you’d like to have a try. But until next time, thank you very much for coming along. Really appreciate your attendance. I hope you got something out of today. It was a lot of fun to have a chat with you today, Joanna, as always. So, and don’t forget, she does know exactly what she’s talking about. So, give her book a read and give her a call if ever you need her assistance in any of these transactions in the future. And with that, I think we’re done for the day.

Brett Goodyer (16:12): Thanks so much.

Speaker 2 (16:13): Thank you very much, everybody.

Joanna Oakey (16:14): Well, that’s it for this episode of The Deal Room Podcast. If you’d like more information about this topic, then head over to our website at thedealroompodcast.com or our legal firm, aspectlegal.com.au. Or if you’d like to subscribe to get an update each time we launch a new episode, or if you would like to book a call in directly with our legal eagles at Aspect Legal to discuss your own transactional legal needs, then check out the show notes for this show on your podcast player for a direct link. Well, that’s it. Thanks again for listening in. You’ve been listening to Joanna Oakey and the Deal Room Podcast, a podcast proudly brought to you by our commercial legal practice, Aspect Legal. See you next time.