Want a piece of the pie? I am seeing more businesses that are considering offering key employees a slice of the business. From the perspective of the potential buyer this article highlights a few advantages and disadvantages to employees taking a share in a business.
Last month I talked about why a business owner might consider bringing on a minority shareholder with a view to eventually having them take over. This month I consider things from the perspective of the buyer.
I am seeing more businesses that are offering employees a slice of the business and the employee wanting advice on whether they should buy in.
So, from the perspective of the buyer, here are a few advantages and disadvantages to employees taking a share in a business.
Benefits of buying into a business
A key first benefit to becoming a shareholder employee (as opposed to any other investment) is the potential for favourable vendor finance terms.
This could mean that the employee might not have to put any money down to get the shares.
This can mean that employees who otherwise would not have the means to be a shareholder can afford to be. There are many ways to structure how the employee might eventually pay the shares off.
A second benefit is the value of buying into a successful business. Some staff come to me saying they have been offered 10 percent of the business and need to decide whether to do the deal or go out on their own.
Of course, there are many factors to consider in order to answer this question – but clearly it may be better to buy into a successful existing business then it is to start your own one. The statistics for how many new businesses fail within five years are quite grim.
Thirdly, buying a small share in a business could be a pathway to full ownership. Lots of employees could never afford to buy the business from their boss outright. However, if they were buying it at 10-20 percent a year then this becomes a viable option.
Not only does the employee eventually get to buy a business they could not have afforded under this option – they have been building the business the whole time they have been a minority owner.
This is likely to make the transition to a new owner more stable – as compared to an outright sale.
Some of the downsides
Agreeing on the value can be tricky. I have seen several examples where an employee has been offered 10 percent of the business – at 10 percent of the business’ value.
Unfortunately (for a business owner) the 10 percent is worth proportionality less as it has less control. If the majority shareholders want to do something – they do it.
The 10 percent owner gets dragged along for the ride. It can be hard for a business owner to stomach a discount of potentially up to half the value of the shares given the lack of control and marketability.
Of course, price is just one aspect of the negotiation – but is important for potential new shareholder employees to understand what their potential investment is worth.
Another downside to taking a minority shareholding in a business is going to be the business partner.
No matter how well you get on, once there are two or more shareholders involved there is some risk that everything gets a bit more complicated.
Many businesses have systems that need strengthening when unrelated shareholders enter the picture.
For example, in your own business you can take out cash whenever you like. But if you keep doing that after bringing in a 10 percent shareholder you could have a problem.
A third downside to buying a small shareholding is that as a shareholder you are tied to the history of that company.
It is important that you do your homework to make sure you are comfortable with that history and there are no skeletons in the closet that will reduce the value of your investment.
Buying into the business you are working in could be a great option – particularly for those with insufficient assets to consider an outright purchase.
If you are ever offered a piece of the pie, make sure you get great advice before you bite in.