When successful businesses are looking for the right exit strategy, trade sales to a third party and management buy-outs are common place. Selling a business to the employees is a less well-known option, but is worthy of serious consideration.
What are the benefits?
When the sale of a business into employee ownership is structured appropriately it can be entirely tax free for the vendor. In addition to the potential tax benefits and providing a non-adversarial market value exit for the vendor, employee ownership can secure the future of the business, which is usually very important for the vendor and the workforce.
We advised an entrepreneur who had received third party offers for his business, but ultimately opted for employee ownership, commenting: “I was concerned that selling to a remote buyer might see one of the branches closed, staff laid off, or clients resigned. We have a loyal and long-serving team, and I wanted to ensure their jobs were secure.”
Employee ownership provides the vendor with much more control over the timing of the sale process, as it doesn’t include a search for a suitable buyer. As the vendor usually remains involved with the business in the early years after the transaction, it can also provide a low-risk transfer of ownership and leadership. Employee owned business are generally reported to have higher employee engagement, increased productivity and innovation, lower absenteeism and a greater ability to attract and retain talent in comparison to other businesses. There can also be tax benefits for the employees who, within limits, can be eligible for annual tax-free bonus payments.
What are the downsides?
Employee ownership may not be appropriate for all businesses.
A culture that encourages participation, and a strong management team behind the owner, are likely to be key traits of a successful transition to employee ownership. As is a fair-minded owner who understands what the business, and their ongoing role in the business, will look like four or five years after the transfer to employee ownership.
The tax savings will, of course, be an important factor, but having tax as the main driver is the wrong way to approach a sale into employee ownership.
How does it work?
There are three models of employee ownership:
- Direct, where the employees become the shareholders.
- Indirect, where an employee ownership trust holds the shares on behalf of the employees.
- A hybrid model of the two mentioned above.
Advice should be sought to determine the most appropriate model.
How is it financed?
Many business owners dismiss the idea of employee ownership as they feel their workforce will not have the financial ability to buy the business. Irrespective of whether they are correct or not, this shouldn’t be a barrier. It is rare for a business to enter employee ownership by the employees contributing funds directly.
Vendor finance is often used. This involves the vendor exchanging their shares in the business for debt, which will be repaid to the vendor, by the business, from surplus cash flow over several years. Typically, the vendor would receive an initial cash pay-out with the balance over three to six years. It is rare in any transaction for a vendor to receive 100% of the cash on day one, as deferred payments are also a common feature of sales to a third party. Moreover, in the case of a sale into employee ownership, the vendor can take appropriate legal security and due to their continuing involvement with the business, are well placed to ensure debt repayments are made in accordance with the agreed timetable.
External debt from a bank or specialized lender can also be used to finance the transaction. There is of course the option to use a blend of all three sources.
In summary
Even if employee ownership is not a concept that is familiar, it could be the right option for your business. If you would like to speak further on selling your business through employee ownership or another exit strategy, please get in touch with your usual Saffery Champness partner, or contact Jamie Lane.
