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How do you evaluate key employee worth in small business sale? What is the appropriate terminology to describe this?

posted by: User51 on 2017-03-29
tagged: tech-company, investors, employees, employee-compensation, private-company
score: 5

In a small small tech SaaS company with SDE around $120k, the owner is looking to sell and retire, but does not want sell to the only employee due to lack of up front capital.

The employee has been with the company 12+ years, and is the only individual with recent and extended knowledge of the program (inside and out), as well as customer support. A “hands off” investor is interested in the purchase the company, and discussion occurs on placing the employee in charge of the full operations of the company, while the investors could merely reap the profits.

For the employee, they recognize their worth to the company. They are under no legal or ethical obligation to stay with the company, and could find comparable or even better employment elsewhere. Further, it stands to reason that without a knowledgeable and experienced employee, the final sale price of the company could be affected, perhaps severly, as it is a moderately sized software package and no one else has recent and detailed, long-term experience with it.

It is a niche market, relatively limited customer base, and is a many featured product that would take a while for even a customer to learn, let alone a new employee to both support and maintain.

For the employee, who has very little incentive to stay, how would the value of that employee be measured, from all three positions? The seller, the buyer, and the employee?

While there are few incentives for an outside investor (they could find another company), what are the considerations for both the employee and the seller, how tondescribe this to both, and possibly ethical considerations involved.

Should the employee just walk away, or refuse a deal with the new owner, the investors would likely walk away, and finding new prospects would be harder (it has been on market for 2.5 years already, and the owner is 70). If the employee stays, without demanding something in return for his ‘expertise’, he would feel disrespected by the owner who feels no loyalty to reward 12 years of service to profit the owner.

Since the only leverage the employee has is with the current owner in the sale, could/should he expect compensation as part of the deal from the exiting boss, perhaps to secure 2-3 years of labor with the buyers, so that everyone is benefitted? The employee would just as soon walk away and find new employment as stay with the company, and the employers fate is of no concern to him.

Should the employee expect anything from the seller, perhaps even a substantial percentage of the final sale price, such as, if the company is worth 50% less if he doesnt go with a sale, could/should he demand a sizable portion of the company sale price from the company owner in the sale agreement? Is there better method of valuation for the employee, and how would one communicate this ethically and clearly?

NOTE: I am mostly interested in the employees position, both in verbiage as well as ethically, but am interested in the others as well, if possible.

Answer 12552

posted by: Marcus D on 2017-04-24
score: 4

I’ll answer this from a few perspectives and make some assumptions as I go …

If I were the current owner

I’m assuming that they want to extract some value for the business. A few ideas

Engage the employee in a staged buy out of the company, maybe using part of their monthly salary to purchase a small number of shares each month. Once there is a changeover of majority control (50%) then the current owner will continue as shareholder and advisor until all the shares have been transferred. This gives a good possibility that the business will succeed (depending on the skills of the employee), as there will be skills and knowledge transfer over a number of years from the current owner to the employee. This only works if the current owner and the employee are getting a reasonable wage.
Find a new owner for the company, with an understanding that there would be a 10-20% stake that the employee would purchase over time. This might be good for the employee as then the skills base for the business would be broader making it have a higher chance of success.
It depends how keen you are to finish working in the business and if you would like to tail it off as a lifestyle business over a few years.

If I were the employee

… and I was not wanting to run the whole business, I would be engaging with the current owner to help choose a new owner that I liked and thought I could work with, also asking for a share of the business to keep my loyalty
… and I was wanting to own/run the business, I would engage with the current owner on this basis, but find a friend/colleague who has run their won IT (preferably) business, and has different skills to me to go into partnership and purchase the business from the current owner. Looking for an ‘investor’ will mean you will lose control.

If you are the investor

I would want to incentivise the employee to stay around and invest further in the busienss. Assuming you like/trust them, I would go for allowing the employee to have some equity.
You could purchase the business, keep the employee on just as an employee (with the risk that they might leave) and engage with a few of the largest customers to understand the business model of the SaaS system to then bring in your own analyst/programmers.

I’m not sure which of the three the OP is … but transition planning is always a tricky thing. I have had friends who have tried doing it and the biggest problem is finding the right person to pass the business onto, in order that the business is most likely to succeed.

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