Employee ownership: A Viable Exit Strategy
At some point in the life cycle of a typical small to medium sized business the owner(s) will turn their minds to the question of their “exit” strategy.The most common goal is to seek a trade sale of the business, or a partial exit involving investment by a private equity firm or similar investor. Another option is the “management buy out” where the key managers buy the business supported by a bank or similar funder. For a larger business, flotation might also be a realistic possibility.
Is there another way?
A new variation on the theme which is gathering pace is the idea of transferring the business into the ownership of employees generally. There is no single model for this but it may be based on any or all of the following circumstances :
- the owner does not wish to pass control to a competitor who may simply take the business and dispense with the services of anyone who does not fit the new corporate culture ,
- the owner is attracted by the proposition, supported by substantial academic research, that businesses owned by their employees tend to perform better than those not so owned ,
- the new regime may involve “all employee” ownership whereby the entire workforce is “engaged”, partly by share ownership, but also by involvement in the decision making processes through new formal structures, in which all employees are invited to contribute.
As this route is still relatively new and less common in the market place, funding can be more difficult. However, several factors may converge to render the prospect viable .
The owner may be willing to accept sale proceeds at the lower end of the valuation range, in the knowledge that the business is being left to a motivated workforce who contributed to the creation of the value, and a structure that may be expected to preserve the legacy long term.
Specialist funders are emerging in the market who are familiar with the issues and may be able to offer suitable terms.
The government is keen to widen employee ownership generally and is relaxing various provisions in both company and tax law in order to facilitate this. For example, private companies may buy back shares in instalments (thus allowing the business time to generate the funds necessary to meet the purchase price). They will also be permitted to hold shares in treasury (thus dispensing with the need for an employee benefit trust to “warehouse” the shares).
There are various ways of creating a new “employee owned” structure.
Direct ownership by employees
This may involve direct ownership of shares by employees (with potential for growth in value in their hands to be taxed more favourably than income and thus enhancing its incentive effect).
Shares might be transferred to employees under one or more of the various government-sponsored tax efficient share schemes for employees (“Enterprise Management Incentive” options, “Company Share Option Schemes”, “Share Incentive Plans”, and so on). The 2013 Budget contained a number of measures to make these plans easier and cheaper to operate.
There are also various government-sponsored tax efficient investment schemes (Enterprise Investment Schemes, Seed Enterprise Investment Schemes, etc) that can be implemented.
And there may even be a role for the government’s proposed “Employee Shareholder” scheme (under which employees trade certain employment rights for shares whose growth in value is potentially free of all tax). This assumes that the government presses ahead despite the recent rejection of the plan by the House of Lords.
Ownership by an employee trust
Alternatively, the shares might be held long term in an employee benefit trust. The trustees act solely to benefit employees generally. Although there are generally few tax advantages in this arrangement, other commercial benefits may make the structure attractive and sustainable ( for example, a more engaged workforce, no need to fund dividends to external shareholders, etc), as exemplified by John Lewis, Arup and similar groups.
A “partnership” ethos might best be achieved for some (with some tax advantages), by establishing a limited liability partnership and giving traditional partnership rights to the workers accordingly (see related article – Cometh the hour, cometh the LLP).
Any of these schemes may involve cash coming into the company and/or going to the former owners, to acquire shares, with tax breaks along the way.
In our experience of guiding business owners through the issues, substantially different structures have emerged to cater for particular circumstances, though the fundamental goal remains the same i.e. of giving the owner an exit from the business while transferring ownership long term to employees.
The support given to this concept by various government initiatives referred to above, and by common interest groups such as the “Employee Ownership Association” is gradually bringing employee ownership models into the “mainstream area of planning a viable exit strategy.