Employee Ownership Explained – Making Employee Ownership Work

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The final webinar in the Employee Ownership Explained series took place on Wednesday 18 November. This month, the focus was on ‘Making Employee Ownership Work’. Having worked in the employee ownership sector for 16 years and supported over 60 companies move into an employee ownership structure, Carole Leslie of Ownership Associates, talked through the process of moving to an employee-owned structure, and how to achieve the best outcome for the sellers, the employees and the business.

The presentation focused on ‘Five Steps to a Successful Employee Ownership Transaction’.

five steps diagram

Step 1: Initial Conversations

It’s worth investing time and effort in exploring the sellers’ aspirations and motivations behind the move to an employee ownership model.   Being clear on the expected outcomes, realistic on valuation, and honest on the company’s prospects will all help achieve the optimum results.

Choosing the right advisory team is key to a smooth and pain free process. A seller is likely to only do this once, so select advisors you trust and feel you can work with. The usual project length is 3-6 months although everyone should be prepared to move deadlines if there is any uncertainty.

Leadership succession planning is critical if a move to an EOT is part of exit planning by business owner. If there is no one to step into the seller’s shoes, then the owner will be constrained from moving on.

The owners’ own financial situation- and that of any family members connected to the business- should be considered. Is everyone making a contribution and if so, does their salary reflect this, bearing in minds dividends won’t be paid if all shares are in the Trust.

Step 2: Valuation

The first potential obstacle is reaching an acceptable valuation.  The feasibility study will report an indicative valuation, and an accountant will confirm or amend this number and provide a repayment schedule. As these deals are largely vendor financed, then the seller must be comfortable with the terms and accept the element of risk to which they are exposed. There will be a number of protections built in to mitigate this risk but the seller must have that confidence that the company will generate sufficient cash to meet the agreed figure.

Step 3: Building the Model

A key question is how many shares will be sold to the Trust? To benefit from the tax incentives, the controlling interest (50%+) must go into the EOT.  If the seller wants to retain a shareholding, they must be realistic about their options to divest in future. A minority shareholding in company controlled by an EOT is unlikely to be an attractive prospect to a buyer, so the obvious buyer would be the EOT once the initial consideration is repaid.

There is usually some reorganisation of the company’s governance structure, with appointing new directors and formalising board procedures.

There should be serious consideration given to the composition of the Trustees. The Trustees are effectively the stewards of the company for the future, carrying many of the same powers as a majority shareholder would in any private business.

If the company has property, there may have to be decisions whether that property remains in the business or whether it is retained by the owner and leased back.

Share schemes are often a feature of employee-owned companies and it’s worth thinking ahead as to whether it is desirable to implement one now, or at any time in the future.

Step 4: Funding

These transactions are largely vendor financed although there is an increasing interest from banks and specialist lenders to support EOT deals. Including external funding can lengthen the process but sometimes this is worth it for reducing risk to seller and formalising loan with company.

 Step 5: Communication

Telling the employees at the right time, in the right way, is critical. It’s usually very unexpected news, and it will be a new idea to most employees. All companies are different and it is worth spending time in using a variety of channels such as all-company meetings, small group meetings, offer of one to one conversations supported by documented explanations to ensure employees see the move to employee ownership as a positive outcome for them.

Consideration must be given to other stakeholders in the company such as customers, suppliers, landlords etc.  No one wants to fall out with their most important customer because they found out about such momentous news in the press!

The presentation was then followed by a panel discussion involving Bill Grossart from Grossart Associates, Innes Chalmers from Scottish Gallery and Sheila and Fraser Dunphy former owners of Finesse Control Systems and an interactive Q&A session, a summary of which is outlined below.

It is worth noting to any clients interested in exploring employee ownership that Scottish Enterprise via Co-operative Development Scotland provides free support including an Ownership Succession Review and an Employee Ownership Feasibility Study. This allows clients to objectively assess whether Employee Ownership is for them and outlines how ownership can be structured, governance and employee engagement within the business and indicates how a deal might be structured including a valuation. To find out more visit: https://www.scottish-enterprise.com/eo

A recording of the webinar can be found here:

A copy of Carole Leslie’s presentation is available here: Making Employee Ownership Work

Panel Discussions:

Bill, you initially chose a different path. Why change direction?
We had received several approaches to buy the business. However, it was a tortuous process with the buyers trying to tie us in, give us targets, and quibble over value. I read an article about the EOT and here we are! It’s been excellent. The team have risen to the challenge and we are having a great year.

Innes, why did the Scottish Gallery opt for employee ownership?
The Scottish Gallery could have been a target for a private buyer. We wanted to protect the Gallery’s legacy as an 170 year old institution.

Sheila and Fraser, why did you choose to sell your shares to an EOT?
It was important to us to keep the business local and protect the ethos of the business.

To all panel, what would you differently if you were to do it again?
Bill Grossart, Grossart Associates: Been pretty seamless. Some obstacles with funding but nothing we couldn’t address.  We found the bank generally supportive.
Innes Chalmers, The Scottish Gallery: We wouldn’t do anything differently.  It took time but we got commitment from the staff and the shareholders and overall we thought the process went very well.
Sheila and Fraser Dunphy, former owners of Finesse Control Systems: We received good advice to point us in the right direction and keep us on track. We haven’t yet come to anything we feel could have been different.

Questions & Answers

What makes the process so expensive?
Most corporate deals do require a lot of expert advice and as the EOT transaction tends to be collaborative, in the context of business sales then it’s probably not as expensive.
Innes: The Gallery didn’t feel the costs were high for the advice received.

If business is regulated by Financial Conduct Authority then can’t move to an EOT without their approval, any advice?
There are a few financial advisory firms going through the process at the moment, and although the FCA approval process adds a complexity, approval will be given if the transaction meets their criteria.

What can advisors be doing more to promote employee ownership?
Employee owned firms have a part to play. Grossart Associates changed our logo and our branding to make sure people knew we were owned by our employees.

Is there a contribution towards fees from Scottish Enterprise?
There is support for a feasibility study for companies looking to explore employee ownership.

What is the advantage of selling to an EOT rather than an established local charity or social enterprise?
There isn’t a definitive answer to this. In some cases a charity or social enterprise is the right solution; it depends on what the desired outcome is.

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