Selling shares to a key employee: how the buy-in gets funded

Your operations manager has run the place for six years. Customers ask for them by name. They’ve started asking, politely, what their future looks like. Offering them a stake is one of the most effective ways to keep a key person and to begin a succession that doesn’t depend on finding an outside buyer.

The sticking point is almost always the same: the shares are worth far more than the employee has in the bank. This guide works through how established New Zealand SMEs bridge that gap, where IRD and the Companies Act come in, and how to structure the deal so the business’s working capital isn’t the thing that pays for it.

Why sell a stake to an employee at all?

An employee buy-in usually solves more than one problem at once:

• Retention. A manager with equity is much harder for a competitor to poach.
• Succession. A 10% to 30% stake now can become a full buyout later, with a successor who already knows the business. Our wider guide to funding a succession covers the longer path.
• Partial liquidity. The owner banks part of the value they’ve built without selling to a stranger.
• Lender comfort. Banks and other lenders like to see depth in management. A business where the second-in-charge has skin in the game reads as a lower risk.

The trade-off is that the owner gives up some control and some future profit, and gains a co-owner who’s also an employee. That dual role needs clear paperwork.

Step one: agree what the shares are worth

Every other decision flows from the price. For an established SME, value usually comes from a multiple of maintainable earnings, adjusted for debt and surplus assets. Our guide on how to value a small business explains the methods.

Two points are specific to a minority stake:

1. A minority stake is worth less than its pro rata share. A 20% shareholder can’t control dividends, sell the company or appoint the board. Valuers often apply a discount for lack of control. Whether you apply one is a commercial decision, but be clear about it.
2. A discount for the employee is a tax event. This is where many owners trip up, so it gets its own section below.

Get an independent valuation, or at least a valuation from your accountant that sets out its method. It protects you both, and it’s the number IRD and any lender will look at.

The tax question: market value, discount, or deferred?

Inland Revenue’s employee share scheme rules apply when shares are issued or transferred to someone in connection with their employment. The taxable benefit is broadly the market value of the shares on the share scheme taxing date, less whatever the employee paid.

That produces three practical scenarios:

The third row is new. From 1 April 2026, an unlisted company can designate shares issued under an employee share scheme as employee deferred shares. The employee’s tax is then pushed out until 20 days after the earlier of the company listing or the shares being sold, transferred or cancelled. Only the employer can make the election, and it must send IRD a web message with the employee’s details, the issue date and the number of shares within 20 days of issuing them.

For a private SME this removes one of the old headaches: an employee taxed on shares they can’t sell, with no cash to pay the bill. It doesn’t remove the need to value the shares properly, and it’s not a reason to discount the price if you’d rather be paid. Run the numbers with your accountant before you choose a column.

How will the employee actually pay for it?

Assume the shares are priced at full value. The employee still needs to find the money. In practice, buy-ins are funded in layers.

1. Their own deposit

Even a modest contribution matters. It shows commitment, and it means the employee feels the outcome. Savings, a bonus or a sale of other assets are the usual sources.

2. A loan in the employee’s name or holding company

This is often the largest layer. Many key employees own a home with some equity in it, and a loan secured on that property is usually the most practical way to raise a lump sum. The loan sits with the employee (or a holding company they set up to hold the shares), not with the trading company.

A property-secured loan can sit as a first or second mortgage behind an existing home loan, and the initial assessment doesn’t need financials. That matters for an employee who may never have borrowed for a business before.

If the employee is thinking about this now, a short enquiry is a sensible first step: see what’s possible here. There’s no credit check at that stage.

3. Vendor finance from the owner

The owner agrees to receive part of the price later, often paid from the employee’s share of dividends. It’s flexible and signals the owner’s confidence. It also leaves the owner as an unsecured creditor of their own employee, so document it properly, set a repayment timetable and decide what happens if the employee leaves. The trade-offs are covered in our guide to vendor finance vs lender finance.

4. Staged tranches

Rather than 20% on day one, the employee buys 5% now and further tranches over three to five years, often at a price set by a formula agreed upfront. Each tranche is smaller, easier to fund, and can be paid partly from dividends on the shares already held.

Most deals combine two or three of these. The test is whether the employee’s after-tax salary plus expected dividends can service their loan and any vendor payments without strain in a weaker year.

What if the company helps fund it?

Owners sometimes suggest the company simply lends the employee the money, or guarantees their bank loan. That’s possible, but under the Companies Act 1993 a company providing financial assistance for the purchase of its own shares (by loan, guarantee or security) must follow a specific process set out in sections 76 to 81, including board resolutions and the solvency test. There are limited exceptions, such as a simplified route for small amounts relative to shareholders’ funds.

None of this makes company-assisted buy-ins unworkable. It means the lawyer drafts the process before the money moves, not afterwards.

There’s a commercial point too. Cash lent to an employee isn’t available to fund stock, debtors or a slow month. Protecting working capital is the same principle that applies to any buyout.

New shares or existing shares?

The mechanics change depending on who receives the money:

• Transfer of existing shares. The employee buys shares from the owner. The cash goes to the owner personally. The company’s balance sheet doesn’t change.
• Issue of new shares. The company issues shares to the employee. The cash goes into the company and can fund growth, and every existing shareholder is diluted proportionally. The Companies Office requires notice of a share issue within 10 working days, and the share register must be updated.

If the goal is the owner beginning to step back, a transfer usually fits. If the business needs capital for an expansion and the owner is happy to be diluted, an issue may suit better. Some deals do both.

Don’t skip the shareholders’ agreement

An employee shareholder is a different relationship from an outside investor. Before any money moves, the shareholders’ agreement should cover:

• Leaver provisions. What happens to the shares if the employee resigns, is dismissed, becomes unwell or dies, and at what price.
• Valuation formula. How shares will be valued on future transfers, so there’s no argument later.
• Dividend policy. If the employee is relying on dividends to repay a loan, they need some certainty about whether profits will be distributed or retained.
• Decision rights. Which decisions need unanimous approval and which the majority owner can make alone.
• Pre-emptive rights and tag/drag clauses. What happens if the owner later sells the rest of the business to a third party.

Your lawyer should also confirm the employee’s employment agreement and the shareholders’ agreement don’t contradict each other.

A worked example

Example scenario, generic and for illustration only. The owner of a Hawke’s Bay engineering business agrees to sell 20% to their workshop manager. An independent valuation puts the whole company at $1.5m, so the stake is priced at $300k at full value, with no employee share scheme discount.

The manager contributes $40k from savings. They borrow $160k through a new holding company, secured by a second mortgage over their home. The owner vendor-finances the remaining $100k, repayable over four years from the manager’s share of dividends, with a clause requiring any unpaid balance to be settled if the manager leaves.

Because the price is full market value, no taxable benefit arises under the employee share scheme formula. The company’s own facilities are untouched, so working capital stays where it was. The shareholders’ agreement sets a leaver formula and an option for the manager to buy a further 20% in three years.

Funding the buy-in without stretching the business

Bringing a key employee into ownership is one of the better decisions an owner can make, and the funding is usually the easiest part to solve once the price and paperwork are clear. We regularly help owners and incoming managers with exactly this kind of deal, whether it’s the employee raising their share of the price against their home or the business arranging a facility so the owner can accept deferred payments without a cash squeeze.

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