Employee ownership

Employee ownership has been recognised for its potential contribution to the economy. A range of factors combine to make employee-owned businesses an asset to the UK economy, and independent research suggests that a combination of shared ownership and employee participation delivers superior business performance. This is driven by all employees working for the business to assist in meeting its future goals.

Benefits of employee ownership:

• The legacy of the business stays intact – the possibility of losing it through a trade sale is avoided.
• There are no adversarial parties to negotiate with.
• Loyal employees remain in gainful employment. They can influence how the business is managed and share in the future reward.
• Tax incentives make employee ownership very attractive to the exiting owners as well as the new employee-owners.

The employee-owned business sector adds to the diversity of Britain’s economy by offering a vibrant and different model for achieving business success.

Employee ownership can be the best way of preserving the business and ensuring that employees retain their jobs. For many owners, safeguarding the future of the business and its employees is an important objective. Completing the buyout helps ensure that the new owners of the business - the employees - are highly motivated. This direction is usually less disruptive than alternatives, particularly as employees avoid the uncertainty of other kinds of sale.

Employee ownership can take one of three forms:

• Direct employee ownership – Using one or more tax advantaged share plans, employees become registered individual shareholders of most of the shares in their company.
• Indirect employee ownership – Shares are held collectively on behalf of employees, normally through an employee Trust.
• Combined direct and indirect ownership – a combination of individual and collective share ownership.

Employee ownership typically occurs via any of the following scenarios:

• Business succession or ownership succession – Private owners, such as an entrepreneur or family business, decide to sell to their workforce. The most typical route into employee ownership.
• Growth and Expansion - Partners, owners, or managers might decide to broaden ownership to cover most or all employees, reflecting the need to attract, retain and motivate talented people.
• Start Ups – As in the case of John Lewis, Arup Group or Scott Bader, the founder of a business opts for employee ownership at the outset of the business or later.
• Insolvency or closure threat – Employee buy–outs can prove an effective route to recovery for businesses that might otherwise fail.

If you are a company owner thinking of selling your business, employee ownership is an increasingly practical and popular option. An employee buy-out is one of the core business succession options for company owners.

Companies facing ownership succession increasingly consider a sale to their workforce because:

• A range of tax advantaged schemes are available, notably the Share Incentive Plan (SIP) or Employee Ownership Trust (EOT), which make structuring employee ownership or an employee buy-out feasible and rewarding for owner and employees alike.
• Selling to the workforce is a way for owners to preserve the integrity and continuity of the business they have built up, while acknowledging the contribution of employees.
• Employee buyouts tend to have a better record of sustainability than management buyouts, so the enterprise the owner created is more likely to survive.
• Employee buyouts are significantly less likely than a trade sale to result in closure of premises and production in local economies which may have come to rely on them for employment and commerce.
• The terms of the employee buyout are, to a great extent, within the owners' control.
• Owners can plan as to when and how the employee buyout occurs. This is a significant advantage over most other forms of exit.
• Employee buyouts have a good record of succeeding. This is important if there is any deferred consideration. Most founders of a business want to see their business survive and prosper.
• An employee buyout is a way of recognising the contribution employees have made to the success of the business.
• Continuity of the business can be achieved for customers and suppliers.
• The way the business is carried on, its ethos, etc, is more likely to continue intact.

Benefits:

• Increases the business performance: Many surveys have shown that employee-owned firms perform much better than other closely held firms.
• Raises capital: This also helps in offering additional capital as the employees would be ready to invest in the company or take lower salaries to help the company grow.
• Shares entrepreneurship: Starting a small business is difficult and sharing the responsibility helps share the burden.
• Attracts & retains employees: By using employee ownership plans, you can easily get the best talent in the market to work for the company and stay for a long time.

The key features of employee engagement typically found in employee-owned companies (regardless of how the employees' shareholding is owned) include access to information, ‘employee voice’ and a commitment to staff training and development.

Employee-owned companies tend to provide more information to employees, and more regularly than other companies.

Research shows employee-owned companies tend to provide employees with a say in their business through suggestion schemes, opportunities to meet top managers, problem solving groups and team briefings.

Employee-owned companies also have an emphasis on staff training and development, with this being used as one of the metrics of success.

These features are found to a greater extent in employee-owned companies than other companies.

There are several alternatives to an employee buyout. It is important to plan your exit well in advance. You could consider:

• A trade sale to another business: This is the most common method of exiting a business. However, it can be time-consuming and disruptive and involves disclosing confidential information to competitors.

• Keeping the business in the family: You need to ensure you have a suitable successor.

• Carrying on yourself: This only postpones the succession problem. Continuing to work after you want to retire is unlikely to be in the best interests of your business or yourself.

• Bringing in new management from outside: You would still own the business and retain ultimate control of how it is run.

• Floating the business on a stock market: This could be an option if you have a strong track record and good growth prospects. However, it is often a drawn out and costly process.

• Selling to the managers: This can be more disruptive than an employee buyout, and demotivating for employees who do not participate in the buyout. An employee buyout can include all the employees and the management.

• You might decide that the business is worth more if you close it down and sell off the assets. Of course, this means that employees lose their jobs. An employee buyout can sometimes save a business in this position.

Changing from a business controlled by an owner-manager to one owned by its employees can represent a big shift in culture. Employees may never have previously thought about the possibility of becoming owners, or they may feel it is too risky for them. They may also be reluctant to become involved in decision-making.

It is essential to involve employees in the entire process of moving towards an employee buyout. As part of this, you should look for ways to share information with employees, such as newsletters and regular meetings. You should also make sure you consult employees on key issues, particularly where this is a legal requirement.

The more time you have, the easier it is to create an ownership culture like this. You also have more options for the way the buyout is financed and organised. For example, employees could be gradually awarded shares, or a Trust could be formed to assist the buyout.

Typically, final planning of an employee buyout takes anything from two to 18 months. Changing the way your business operates can be the most important - and challenging - part of the process.

Advantages:

• Tax efficient for the selling shareholders and the employees in terms of CGT, inheritance, and income tax reliefs.
• The company will be in the hands of the employees who will be highly motivated to see it succeed.
• Sickness and absenteeism tend to be less in employee-owned companies.
• The existing management team of the company can remain in place after a sale to employees.
• Sales of shares to employees tends to be a quicker process than a sale to an unrelated third-party purchaser.

Disadvantages:

• When selling shares to employees, it is necessary to obtain a market valuation of the company so the sale price can be agreed. It is important not to overvalue the company, as the purchase price will need to be paid by the company itself, potentially being a drag on future profits.
• Selling shareholders will be paid overtime as opposed to the cash they would receive in a market sale.
• If the company’s performance declines after a sale to an employee purchase, repaying the funding used to buy the shares can be problematic.

Start-ups

Introducing employee ownership at the start of the life of a business demonstrates a clear commitment to a collaborative approach to working, and establishes a way for employees to have both a say and a financial share in the success of the new venture. This can be done using the grant of share options, issuing shares into an employee Trust, or even establishing the company with 100% of a company's shares in an Employee Ownership Trust.

As a growth strategy

In an established business, employee ownership provides a way to develop and grow a company. The Nuttall Review highlighted how employee ownership can drive innovation in a company, as well as achieving greater employee commitment and engagement. Introducing direct share ownership by employees can align well with this aim because an increasing share price can demonstrate clearly to employees that growth is being achieved.

Management succession

Employee ownership can provide an alternative approach to management succession where senior managers have previously been expected to buy shares in a company in order to gain promotion. The Trust model of employee ownership provides a way to promote individuals to senior positions, without the need for those individuals to buy a stake in a company. In this way promotion can be based on merit rather than also, in part, on the ability and willingness to invest in a company.

Ownership succession

Employee ownership can have clear advantages over alternative succession strategies. It is more advantageous than a trade sale by a founder to, say, a lifelong competitor, and better than reshaping the business so that it is suitable for a stock market listing. It is also more attractive than the idea that the business could, over a period, be wound down and all staff made redundant. A management buyout might have potential, but why sell to a few when the sale could be to all staff? Why not implement an employee buyout?

Business rescues

Employee ownership can also be used in business restructuring and rescues. There must, of course, be a viable or potentially viable business. There are examples of employees accepting changes to their terms and conditions of working, including redundancy and pension arrangements, in exchange for introducing employee ownership into the restructured business.

Employees can own a business in many ways, either directly or indirectly.

The choice is often determined by the size of the business and the number of employees. For example, a small buyout might choose a co-operative model with an Industrial and Provident Society or a share company structure.

Employee trust

A common method is to set up an employee Trust that holds shares on behalf of the employees. This can be a very flexible solution. The Trust might hold the shares forever, or distribute them to individual employees, or a combination of the two. It can buy shares back from employees who want to sell (for example, when they retire).

Putting shares into an employee Trust can have tax advantages if the deal is structured in the right way. Using a Trust may also be an effective way of raising bank finance to acquire the shares.

Direct ownership

Employees can also own shares directly in their own individual names. One way is for employees to acquire shares over time, as bonuses or part of their remuneration. Some share schemes offer tax advantages to the company and employees.

Alternatively, the shares in the company could initially be bought by an employee Trust which later distributes them. Or some shares could be owned directly by individual employees, while an employee Trust owns and keeps the rest.

The employees may choose to form a co-operative that then acquires the business. You can find out more about forming a co-operative from Co-operative Development Scotland.

Choosing the right form of ownership involves complex issues. For example, you need to decide whether employees will be able to sell their shares - and if so, to whom. There can also be important tax implications. You may want to take advice on what best suits your objectives.

The first step is to check that an employee buyout is a realistic option.

• What are the objectives of the owner (s)?
• What do the employees want?
• A rough assessment of how much the business is to be sold for and its prospects is important.
• Would a buyout be financially viable?

If a buyout seems a possibility, more detailed plans need to be developed. The business plan is likely to need updating to take account of the planned changes and to help raise any financing. The proposed structure for the employee buyout needs to be decided, considering the tax consequences.

You will also want to agree a preliminary timetable for the buyout. At the same time, you should start developing plans for after the buyout has been completed andinvolving employees is a key part of this.

The price and terms and conditions of the deal can then be negotiated in detail. At this stage, both owner and employees will need specialist advice, though they may well have involved advisers much earlier in the process. At the same time, financing can be arranged.

Once everything is ready, final documents are signed, financial arrangements are put in place and the deal is completed. The new owners take control of the business.

Read our guide, Complete the sale of your business.

The financing of an employee buyout depends on the financial viability of the business and how the buyout is being structured. The right solution may involve a combination of several different options.

Various financing options can allow the business to be sold for a fair price, even if the employees could not normally afford to buy it outright. Some business owners choose to sell their business to the employees for less than the full market value. There can also be tax advantages if the buyout is structured in the right way.

If shares are being bought by an employee Trust, the Trust may be able to borrow from a bank - particularly if the business has strong, predictable cashflow and good asset backing. The Trust then uses future business profits to pay interest and make loan repayments.

As well as banks, there are also a number of specialist lenders that finance employee buyouts, for example Co-operative and Community Finance.

Alternatively, the owner of the business can help finance the business by agreeing to accept payment over time rather than all at once. Owners who have faith in their business - and support the idea of an employee buyout - are often willing to do this.

Employees themselves can also help finance the buyout. They can finance the gradual acquisition of shares by taking shares or share options as part of their remuneration, or they can invest their own savings.

As the financing structure can also have important tax consequences, you may want to take specialist advice.

Read guidance on how to choose and collaborate with an accountant.

Once the buyout has been completed, the business normally continues to be run as a profit-making enterprise. In many cases, the same managers continue to run the business, and the same employees work in the business - even though the employees are now the owners. But both employees and managers need to understand their new roles.

Employees are likely to need training in their new role as owners. For example, they may be responsible for voting to elect directors to the Board of the company. In a small buyout, employees may be taking on new supervisory or management roles and need to learn new skills.

Managers and directors also need training and support. They need to understand the crucial importance of effective communication within the business to avoid conflict. They also need to maintain a culture of employee participation, which should have been developed before the buyout happened.

Employee engagement

Employees must have a say in how the business is run.

Different ways of engaging employees are suitable for different businesses, but can include:

• An employees’ council, or other consultation group.
• A constitution defining the company’s values and its relationship with employees.
• Employee directors on the Board, with the same responsibilities as other directors.
• Working with trade unions on issues like pay and conditions.

If shares are owned by an employee Trust, the Trust must have trustees - some of whom are likely to be employees. The Trust may run an internal market in shares, allowing employees to buy or sell shares in the business. Or the Trust might distribute dividends to employees.

The trustees will need specialist advice.

5 key traits of successful employee share ownership plans:

• Be simple – Well thought out and easy for all staff to understand.
• Be applicable – Applies to all staff consistently (although you can choose to offer greater reward to levels or staff or for relevant outcomes for which employees have control).
• Be transparent – Communicated clearly and without ambiguity. All performance indicators must be able to be measured objectively and progress communicated regularly.
• Be reliable – Once communicated, they should not change often.
• Be supported – The system must be supported by all company owners, Board, and management.

There are several organisations that provide help and support for employee buyouts:

• Employer Ownership Association (EOA), the association of employee-owned and trust-owned businesses, offers information and advice.

• Co-operative and Community Finance offers loans for employee-owned businesses.

• Co-operative Development Scotland (CDS) offers hands-on advice and support.

Your local Business Gateway can also provide advice and put you in touch with local support services.

In addition, both the business owner and employees will need professional advisers such as lawyers and accountants to help negotiate the buyout. If an employee Trust is being set up, the trustees also need advice. If you can, it makes sense to get advice from specialists with prior experience of employee buyouts.

Read guidance on how to choose and work with an accountant.

Owner, employees, and trustees all need independent advice as their interests are not necessarily the same.