Selling Your Lab to Your Employees
Posted Apr 28, 2011 in Management
When it comes to selling your laboratory, you may have a ready market right under your nose: your employees.
Arranging a sale to employees allows the business to continue with those who helped build it and know it best. It also gives them an ownership opportunity they might not otherwise have. "Selling to my employees allowed me to give the people who worked so hard for me over the years the chance to perpetuate the business as their own and build their futures," says Jim Chmel, chairman of the board of E.C. Chmel, Inc., Eau Claire, Wisconsin.
In addition to not having to "shop" your business around to potential outside buyers, another benefit for the owner is that you may have a better chance of controlling your terms of involvement in the business after the sale, whereas a third party may want you to stay longer than you'd like--or not long enough.
Despite these advantages, selling to employees is a complex process that requires preparation. Having a plan that spans at least five years in advance of the transfer of ownership allows you to work with your attorney and accountant to structure the type of sale that's best for everyone involved, get third-party valuations, consider tax implications and educate employees on how it will all work.
Planning in advance also gives you ample time to address some of the potential obstacles. First, you must have employees in place who are capable of running the business after your exit. For instance, when Reynolds Challoner purchased Lord's Dental Studio, Green Bay, Wisconsin, in 1990, his plan was to ultimately sell it to his employees, so he was deliberate in his hiring.
"I knew I needed a strong operating team with the skills necessary to run a business. I focused on finding four different skill sets: a strategic thinker, a financial whiz, a strong marketing/salesperson and a technical leader," says Challoner. "Those are the four legs of the stool that every successful lab needs." Throughout the next several years, those four people comprised the steering committee that guided the laboratory through the process of selling to employees.
Challoner also addressed another possible hurdle shortly after purchasing the laboratory: how would employees afford the down-payment when it was time for the sale? To help them build a pool of money, he implemented an incentive program for all employees in management positions. They received an annual bonus and, if they were interested in buying part of the laboratory down the road, the bonus went into an incentive account until the sale. Employees who preferred to have the bonus immediately in cash received it at a discounted rate.
The time line: Three years before Challoner planned on leaving the lab, he and the steering committee began to set the plan into action. To give the members of the steering committee a taste of ownership, and to allow them to demonstrate their earnestness, Challoner offered to sell them 10% of the company. They jumped at the chance and used their houses as assets to get financing from the bank.
Then he stepped back. "I had to relinquish a lot of my responsibilities. I had to see that they could run the laboratory on their own; they had to see that, too, and so did the other employees," says Challoner.
Shortly afterward, in order to arrive at a fixed, final sale price, the laboratory underwent three different types of valuations by a business appraiser. Challoner and the steering committee agreed on the current value of the laboratory and then, based on earnings from the past few years, projected its value three years out.
This can be a trying part of the process; Challoner found it helpful to hire a consultant to help with the negotiations. "When you're coming up with an agreed-upon price, you really have to look at your relationship as a buyer-seller one, not as an employer-employee one, and the consultant helped us do that."
At this point--though the sale was still three years away--the opportunity of ownership was extended to all 16 members of the lab's management team; in addition to the four members of the steering committee, 12 more employees opted in. The plan was that, on the day of the sale, the 16 employees would do a straight buyout of the remaining 90% of Challoner's interests.
There was a concern, however, that the employees wouldn't be able to get a bank loan based simply on their skills rather than personal financial resources. In order to help reduce the amount of financing they needed, Challoner offered to loan back part of the sale price of the lab. "Once my wife Barbara and I knew how big the pie was, we decided how much of it we could offer as a loan and how much we wanted in cash to secure our retirement--because we weren't going to risk that," he says. In addition, to show that the business had substantial growth potential and to gain additional leverage for bank financing, they opened a second facility in Milwaukee.
Two years later, the Milwaukee facility began to substantially increase the company's earnings, but Challoner was still apprehensive about whether or not the employees could get financing when it was time to purchase the laboratory. "I asked the steering committee to go to the bank in advance to say, 'Here's the situation: will we be able to get financing a year from now?,'" says Challoner. "They came back and surprised me by saying, 'The bank will do it now. Do you want to do it now?'"
Challoner agreed to move the date of the sale up, with the bank financing, the accrued money in their incentive plans, additional financing from third-party lenders, and the loan from Challoner, 16 employees became the new owners of Lord's Dental Studio in March 2000. The laboratory is now led by Don Warden, president; Ken Mathys, CFO; Kris VanLaanen, vice president of technical operations; and Julie Stadtmueller, director of marketing and sales.
Other scenarios: Of course, there are a variety of ways to structure a sale to employees. For instance, Dick Pilsner, D&S Dental Laboratories, Waunakee, Wisconsin, is using an approach that's similar to Challoner's, except that the buyout is happening more gradually as employees buy stock in the company. In 1999, the laboratory corporation cashed in a 20-year-old life insurance policy that it had invested in for Pilsner and three key employees. This gave the lab a lump sum with which to buy 45% of Pilsner's shares so that the stock could be put up for sale to employees.
All 80 employees in the laboratory, including technical, sales and administrative staff members, were given the opportunity; 13 of them decided to buy in, many of them financing the shares through a bank or through Pilsner himself.
Pilsner and his wife Sally still own 55% of the business and will retain 51% until they leave the laboratory in two or three years; at that point, the additional shares will go up for sale. In the meantime, they've left some shares available for purchase to employees who haven't been able to afford it this far, or for new employees who may want to take advantage of the offer.
Pilsner is still the full-time president, but who will take on his leadership role once he leaves the lab? "We may have 13 or more shareholders at that point, but that doesn't mean everyone can run the show," says Pilsner. "There may be employees with management responsibilities and no shares, or those who hold shares but no management responsibilities. The key is to make it as democratic as possible so we've decided to elect a board of directors, which will then elect officers to manage the business."
Another option for transferring ownership to employees is an Employee Stock Ownership Plan (ESOP). Although the most widely used purpose of an ESOP is to provide a retirement plan for employees, it can also be an effective means of selling the business to them. Generally, the company borrows or uses available funds to buy the shares from the current owner and contributes those shares to an ESOP trust. "All employees who have been at the laboratory for at least three years receive stock annually--in amounts proportionate to their earnings," says Chmel, who is semi-retired from the laboratory but still owns 49% of the stock. Once the current amount in the ESOP trust is depleted, the trust will begin buying out Chmel's remaining shares.
Benefits of the ESOP are that employees don't have to put money upfront or get financing and, when structured correctly, they can be advantageous in terms of tax implications to both the seller and the buyers. However, it can be a very complicated and costly process. "There are numerous requirements and IRS regulations you have to follow, so be sure that you get professional advice from someone who specializes in them," says Chmel, who paid his attorney about $30,000 to set up his ESOP.
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