Achieving an employee buyout

1 Overview
2 Why consider an employee buyout?
3 Alternatives to an employee buyout
4 Planning for an employee buyout
5 Forms of employee ownership
6 Key stages in an employee buyout
7 Financing an employee buyout
8 Running the business after an employee buyout
9 Help and advice for employee buyouts

1. Overview

If you own a business, you need to decide what will happen when you want to retire or sell the business. It's worth thinking about this sooner rather than later, so that you have as much time as possible to plan.

An employee buyout can be a good way of ensuring the future of the business, with a highly-motivated workforce. It can also be an effective way of realising a good price for the value you have created.

This guide explains the advantages of an employee buyout and the key issues you need to consider.

2. Why consider an employee buyout?

If you want to retire, or to sell your business, you need to decide how to organise your exit from the business. Many business owners find that an employee buyout is an attractive option.

With an employee buyout, ownership of the business passes to the employees, either directly or through a trust. Unlike a management buyout, all the employees are involved.

An employee buyout 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.

An employee buyout can be a very effective way of organising your exit. It is usually less disruptive than alternatives, particularly as employees avoid the uncertainty of other kinds of sale. A buyout can also be completed without disclosing confidential information to competitors.

3. Alternatives to an employee buyout

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

  • A trade sale to another business. Perhaps the most common method of exiting a business. It can be time-consuming and disruptive though and involves disclosing confidential information to competitors.
  • Keeping your business in the family. You need to be sure that you have a suitable successor.
  • Carrying on yourself. This only postpones the succession problem though. And working on after you want to retire is unlikely to be in the best interests of your business or yourself.
  • Bringing in new management from outside. But you would still own the business and retain ultimate control of how it is run.
  • Floating the business on a stock market. Can be an option if you have a strong track record and good growth prospects, though it's 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 don't 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, and your reputation could suffer. An employee buyout can sometimes save a business in this position.

4. Planning for an employee buyout

Changing from a business controlled by an owner-manager to a 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 feel that it is too risky for them. They may also be reluctant to get involved in decision-making.

It's essential to involve employees in the whole 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.

5. Forms of employee ownership

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

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

Employee trust

Another 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 a good 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, perhaps 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.

6. Key stages in an employee buyout

The first step is to check that an employee buyout is a realistic option. What are the objectives of the owner - and what do the employees want? A rough assessment of how much the business is to be sold for and its future 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, taking into account the tax consequences.

You'll probably also want to agree a preliminary timetable for the buyout. At the same time, you should start developing plans for once the buyout has been completed. Involving 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.

7. Financing an employee buyout

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.

Different 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 and Baxendale.

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 work with an accountant.  

8. Running the business after an employee buyout

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 to 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 relatively 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 good 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.

Managing ownership

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.

9. Help and advice for employee buyouts

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

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.

Business Gateway can offer you advice on other areas of starting and running a business. Contact us on 0300 013 4753.

Contact your local Business Gateway office.

Your local office will be able to answer your questions on this or any other business subject. 

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