What is this article about?
This article deals with another type of buyer for your business that it is often neglected. Your employees are a potential buyer of your company. In this article we try to help to determine if employee ownership is the right strategy for you and your business?
- These are the items that will be discussed in the article:
- What is an employee-owned business?
- How does an employee-owned business work?
- What are the benefits?
- What are your next steps?
- Where do employees get the funds from?
- Who has the say in appointing management?
- What if the company gets in financial difficulty?
- How CFIE can help
What is an employee-owned business?
- An employee-owned business is one where the employees, rather than external shareholders, hold a significant stake (majority of shares) in the company.
- It is a proven business model to better engage, reward and attract staff.
- It is also a succession option that allows you to exit your business at your own pace, safeguard jobs and improve employee engagement.
- It allows you to achieve a fair price for your business and there can be tax advantages in selling your business to your employees.
How does an employee-owned business work?
- The employees would have an individual shareholding, or hold shares indirectly using an Employee Ownership Trust. Many companies combine trust and share ownership in what is often called the hybrid model.
- There is no one model of employee ownership. The structure can be shaped to fit with your company and your aspirations as an owner.
- The usual process is to form an Employee Ownership Trust, which purchases the shares from the owner. The Trust holds the shares on behalf of the employees.
- The company’s management still run the company, with the board of directors responsible for the success of the business.
What are the benefits?
- Employee ownership gives employees a meaningful stake in their organisation together with a genuine say in how it is run.
- You, the business, and the employees will benefit from:
- Competitive price and guaranteed exit for the owner;
- Safeguarding the future of the business;
- Ownership and leadership transfer at low risk;
- Enhanced employee engagement;
- Increased productivity and innovation;
- Attracting and retaining high-quality talent.
What are your next steps?
- Succession is inevitable, but it is surprising how many business owners put off thinking about it until very late in the day. With so many founder-owned and family businesses facing transitions over the next year, it is essential they know all the succession options, so they find the best way forward for themselves, their communities, and the economy.
- You may find your ideal succession solution is a lot closer than you thought.
- Are you ready to begin your Employee Ownership transition?
- If you are thinking of selling your business and want to discuss an exit strategy, why not contact us for initial discussion to start exploring the best employee ownership model for you and the company you have built up.
Where do employees get the funds from?
- Funding an employee buy-out will depend on the type of transaction that is acceptable to all sides involved.
- This could be a direct sale to the employees in the form of a worker cooperative with the owner receiving cash upfront and leaving the business immediately. In this case, the employees become equal shareowners and buy 100% of the business through external debt or equity financing. We can provide specific advice to both parties on financing and structing a conversion to a cooperative.
- A second option is to sell the business to an Employee Ownership Trust, or EOT, but how is the sale financed? This is an important question, as often business owners looking at a third-party sale and they need to understand whether they will receive cash at completion and, if so, how much. This allows them to make an informed decision as to the best sale alternative. While there are a number of reasons to sell to an EOT other than the cash received at completion, it is certainly an important consideration.
- The owners of the business sell their shares (at least 50.1%) in the company to a trust (the EOT) at a fair value – determined by an independent valuation. The purchase price is paid by the EOT over time (typically 2-7 years) from the after-tax profits of the company, effectively an ‘earn-out’ structure. The EOT becomes the owner of the company and is administered by trustees on behalf of the employees. The trustees typically include the previous business owners, an independent chairman plus employee representatives.
- Therefore, we need to look at several factors. First, is there any excess cash on the balance sheet? Excess cash would be cash in excess of that required to operate the business. If so, the excess cash would be added to the equity value of the business and can be paid out as part of the purchase price on a tax-free basis. While it is always a positive to be able to distribute cash on a tax-free basis, for most businesses this will not be significant enough to sway an owner’s decision on the type of sale to undertake. The most important factor in determining potential cash available at completion is the debt capacity of the business. While lenders look at debt capacity in several ways, the primary factor is the cash flow available to support the repayment of the debt. Understanding the minimum debt service coverage required by lenders will then let you determine how much debt the company can support, given typical repayment terms. As lenders typically require repayment over a maximum five to seven year period, knowing the required debt service coverage ratio allows you to back into the amount of debt the company can support.
Who has the say in appointing management?
- An essential ingredient of co-operative employee ownership is ensuring effective employee voice and governance. Employees should have a right to participate in the governance and, where appropriate, management of their business. They should have easy access to relevant information relating to the success, or otherwise, of the business that they own.
- However, it is important that some form of mechanism is put in place to ensure:
- that there is some form of representation or democratic voice for employees at board level;
- that employees are able to hold the board of the directors to account for the running of the business, either directly or indirectly through elected trustees;
- that employees are encouraged to improve the business and play their part in identifying and implementing suggestions;
- that there is a regular flow of relevant information, delivered in a way that employees understand, relating to the progress the business is making in relation to its stated objectives.
- Employee owned business use a variety of methods to provide governance and employee voice. These may include: Employee directors Employees elect a fellow (often non-management) employee to become a director of the business.
- In the case of an EOT, where the owner-founder stays on in the business for a given period, then the new employee owners also stay on, then obviously management roles continue as before.
- In the case of a worker cooperative, the owner-founder will obviously leave the business immediately (unless otherwise negotiated) and the employee-owners will determine and appoint management roles in the most democratic way possible.
What if the company gets in financial difficulty?
- First of all, based on a thorough due diligence audit and in line with international guidelines for transitions to employee ownership, it is expected that the business to be converted is profitable and has audited accounts over a 3-year period as proof.
- However, I have already worked on several transactions which involved the conversion of businesses on the verge of bankruptcy. In the case, the lenders and financiers of any transaction should be involved from the start. This point, of course, will depend on the current debt level of the business as well as the capacity of the business to support any further debt.
- I have also seen cases where local, regional, national, and even, European subsidies have been allocated to SME transitions to employee ownership in order to save jobs and protect local communities from further businesses disappearing altogether.
- Once a conversion to employee ownership transaction has been agreed on, financed and the new business starts trading, it operates in an open market place facing all the potential risks like any business.
- Therefore, if an employee-owned business were to encounter financial difficulties for whatever reason, then the same solutions apply as to any other business: debt re-negotiation, job losses, cost-cutting measures, and, ultimately, in some cases, employees can lose all or part of the funds invested.
- All of the above-mentioned apply to direct ownership, indirect ownership and worker cooperatives.
How CFIE can help
- We can help you decide on the best model of employee ownership for you and your business.
- Once you have submitted your enquiry an adviser will be in touch to discuss your needs. To help inform this discussion they will ask for a copy of your business plan and, if available, the last three years' of your company accounts.
This article has been written by Carl Pitchford who is an European M & A Advisor with Corporate Finance in Europe. Carl is also active as Due Diligence Auditor, Advisor in Alternative Employee Ownership solutions and a Senior Professor in Business, Finance & Operations. For more information on Carl please visit https://www.corporatefinanceineurope.eu/advisors/mergers-acquisitions/carl-pitchford.htm