8 min read
In the last two years, the number of UK Employee Ownership (EO) businesses has doubled. This is because, if structured correctly, they can match the value of trade sales but with a capital gains tax of 0% to the selling shareholders. They can also create a more productive employee-driven business. Furthermore, a sale can be immediate, as there are no confidentiality or auction process issues.
Despite the attractions, many are put off, or simply do not understand, the approach. The objections are usually it is complicated, my staff could not run the business, or I will get a higher value if I opt for a trade sale. Yet, in the vast majority of cases, these objections are unfounded. To examine each:
Instruct expert help to manage the process especially the transition of ownership into an incorporated trust company. The business, in the form of majority shares, is sold to the trust to be owned for the benefit of the employees. The day-to-day operations of the business remains with the board and management team. HMRC is proactive in approving this approach as the Government actively wants more employee-owned businesses because they believe, and data suggests, that they are more sustainable and productive.
My staff could not run it
Most Employee Ownership sales are structured to pay the sellers with an attractive interest yield over 5-7 years. This means that there is time to build a management team beneath selling shareholders, and, if it is beneficial for the business the selling shareholders can remain as employees for the duration of the payments. This enables a gradual exit giving time to build both an Employee Ownership culture and a robust management structure. A win-win for all involved.
Trade sales have higher values
This is probably true if a sale can be secured by a strong strategic buyer. That is, one that secures economies of scale, synergy and shareholder value from a purchase. However currently matching these three elements, when many buyers are highly cautious of overpaying for acquisitions is not easy, especially with good, but not exceptional, target business for sale. When adding in the tax benefits to the financial modelling, good businesses may see the balance tipped towards the option of a transfer to Employee Ownership.
Employee Ownership sales are thus highly achievable and attractive exit options to many shareholders. The key is in building the correct model with expert help. From a value perspective, this usually means blending vendor loans with some retained profits and possibly third-party debt to structure the value. Vendor loans are particularly attractive for sellers as they come with a yield and, as they are a promise to pay, do not sit on the balance sheet as a liability affecting the creditor figure. Further terms can be extended if there are cashflow issues. Flexible funding options are available so long as you sell a minimum of 51% of the business to an Employee Ownership with the added attraction that this currently has a 100% Capital Gains Tax exemption.
Building a team to lead an Employee Ownership simply takes time and commitment alongside training and support. It is vital that exit shareholders do not retain control so that they can secure the tax breaks. This means appointing the right trustees and establishing the correct board of governance are critical factors, sometimes alongside recruitment to create a successful handover over time. The minimum number of employees for an Employee Ownership sale is based on the number of owners compared to the number of employees, but in general, Employee Ownership can work for companies with as few as 6 employees, where for example there is a single business owner.
Often in small businesses, owners, for example, are still the lead salesperson and as such will need to be replaced when they choose to exit their role, but as we have said an exit can be gradual over time so long as there is a change of control on the sale of the shares. Role and ownership are treated separately, and sellers can stay involved. There, is an annual income tax-free cash bonus for employees paid out of business profits to encourage a continued engagement in the structure.
Employee Ownership is where all employees have a ‘significant and meaningful’ stake in a business. This often means they are more productive due to the ‘buy-in’ culture they create. They provide an effective exit strategy which enables the company to stay independent and the culture to be maintained. Traditional trade sales and Private Equity transactions still remain the most favoured and are currently highly active, however, Employee Ownership is a very strong third option to examine, especially in the COVID era. They can be immediate, with low transaction risk and minimal business disruption. They do however require some preparation and planning, particularly around the strategy and business structure to ensure success.
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We have launched our ‘Lead Ahead’ Webinar Series in line with our weekly articles. Join our ‘Why some Employee Ownership sales can beat trade sales’ webinar on 20th August 2020, 9.30 to 10.30 (BST).
For information on other webinars within the series, visit our Webinars & Events page.