BUYOUT - Employee Ownership

SimplyBUYOUT

A guide to employee buyouts andbecoming an employee owned business

A good number see employee ownership as complex.It need not be. e company can be much like anyother company. What is different is how it is owned.

Co-operative models are a welcome part of theemployee ownership landscape here and abroad. ereare many leading employee owned businesses that canbe classified as co-operatives under acceptedinternational definitions. I have helped to advise andform many myself. Co-operative forms of employeeownership help to underpin an active role foremployees in terms of governance and accountability.

e review I conducted for the Government onemployee ownership, which reported in 2012,concluded that clear advice and information is now akey requirement, particularly at the point of businesssuccession and transfer. I warmly welcome this guideas key to this and wish you the best for using it.

Graeme NuttallPartner, Field Fisher Waterhouse LLP and author of Sharing Success: e Nuttall Review of Employee Ownership.

Simply Buyout: A guide to employee buyouts and becoming an employee owned business

ForewordEmployee ownership is high on the business and economicagenda and for good reason. Where a business is owned by itsworkforce, everyone has a stake in success. e longevity ofcompanies with employee ownership is impressive. eirproductivity is undoubted.

Introduction .................................................................................................................................................................................... 2

Who this guide is for and what it hopes to achieve ............................................................................................................... 2

How to use this guide ....................................................................................................................................................................... 3

1 What is employee ownership and why choose it? .................................................................................... 4

1.1 What is employee ownership? ............................................................................................................................................ 4

1.2 The routes to employee ownership ................................................................................................................................... 5

1.3 The benefits of employee ownership ................................................................................................................................ 9

2 Choosing an employee ownership model and considering methods of governance ...... 11

2.1 The different types of employee ownership models ................................................................................................. 11

2.2 Direct ownership ................................................................................................................................................................... 11

2.3 Indirect ownership ................................................................................................................................................................ 14

2.4 Hybrid ownership .................................................................................................................................................................. 15

2.5 Methods of governance ...................................................................................................................................................... 17

3 A co-operative dimension ........................................................................................................................................ 19

3.1 Voluntary and open membership ..................................................................................................................................... 19

3.2 Democratic member control ............................................................................................................................................. 20

3.3 Member economic participation ..................................................................................................................................... 20

3.4 Autonomy and independence ........................................................................................................................................... 21

3.5 Education, training and information ............................................................................................................................... 21

3.6 Co-operation among co-operative employee owned businesses ......................................................................... 22

3.7 Concern for community ...................................................................................................................................................... 22

4 Key stages to achieve an employee buyout ................................................................................................. 23

4.1 Establish that a buyout is in principle possible ........................................................................................................... 23

4.2 The valuation, financial analysis and projections ....................................................................................................... 24

4.3 Considering financing options .......................................................................................................................................... 24

4.4 Detailed presentation of investigation findings ......................................................................................................... 25

4.5 Preparation of legal structure and legal documents ................................................................................................. 26

4.6 Written offer, subject to contract .................................................................................................................................... 26

4.7 Conclusion of negotiations on terms of sale ............................................................................................................... 26

5 Next steps ........................................................................................................................................................................... 27

Acknowledgments .................................................................................................................................................................... 29

Simply Buyout: A guide to employee buyouts and becoming an employee owned business

Contents

ere are many individual success stories, whether theiconic John Lewis Partnership with a turnover of£9bn, Mondragon Co-operative Corporationemploying 83,000 people around the globe or themany smaller worker co-operatives such as EdinburghBicycle Co-operative with 100 worker owners andforecast to double in size by 2017.i

Evidence shows that whereas only 65 per cent ofconventional businesses survive the first three years,over 90 per cent of co-operatives are in still inbusiness.ii

Research shows that, because employees in employeeowned businesses share ownership and control, theyincreased their productivity over a four year period by33 per cent, whereas employees of conventionalbusinesses improved by just 17 per cent.iiii

So the reason for the employee ownership sectoraccounting for only 2–3 per cent of GDP is not dueto failure rates or poor productivity, but the lack ofawareness of the model by owners, employees andprofessional advisors.

Worker and employee owned co-operatives form partof this wider employee ownership sector and offer areal option for those wishing to embed democraticand ethical principles into their business. is modelneed not be seen as a more complicated or radicaloption and this guide will show you why.

Who this guide is for and what it hopes to achieve

A key finding of the 2012 Nuttall Review of EmployeeOwnership was the lack of awareness of employeeownership. is was cited as one of the barriers to thefurther uptake of employee ownership in the privatesector. Simply put, employee ownership is not widelyknown and is undermined by misperceptions,

therefore opportunities to adopt employee ownershipare lost when employers, employees and advisors areunaware of its relevance and benefits.

is guide has therefore been produced for businessowners, employees, professional advisors andindividuals who are interested in what employeeownership is and how to create it, either as a result ofan employee buyout of an existing business, orthrough the establishment of a start up business.

is guide focuses on how co-operative principles andways of working can be enshrined into employeeowned businesses.

is guide aims:

1. To develop a basic understanding of whatemployee ownership looks like for those unfamiliarwith the model;

2. To provide an outline of how employee buyoutscan be achieved;

3. To signpost to specialist employee ownershipexperts who can help to create successful andsustainable employee owned businesses enshrinedin co-operative principles.

4. To inspire people to convert to employee ownedbusinesses by showing a variety of models thatcould be adopted.

is guide has been written largely from theperspective of completing an employee buyout in abusiness succession scenario. However, the majority of the information contained within applies equally to other situations where employee ownership is being considered.

Simply Buyout: A guide to employee buyouts and becoming an employee owned business 2

IntroductionEmployee owned businesses can be found succeeding across theeconomic sectors and operate at all levels. ey are characterisedby greater employee engagement, higher productivity, resilienceto economic downturns and better connection with their localcommunities.

How to use this guide

e guide is split into different sections covering thefollowing areas:

1. What is employee ownership and why choose it– what we mean by employee ownership, thedifferent definitions of employee ownership, thebenefits associated with employee ownership andthe academic research supporting it;

2. Choosing an employee ownership model –explaining the key models that are oftenimplemented and highlighting their respectiveadvantages and disadvantages;

3. A co-operative dimension – the key factors that need to be addressed in order to enshrine co-operative principles into an employee owned business;

4. Key steps to achieve an employee buyout – astep by step guide to the key actions and decisionsthat need to be taken to complete a successfulemployee buyout.

5. Next steps – signposting to specialist organisationsthat can help to deliver successful employeebuyouts and suggestions of further reading andresearch into employee ownership.

is guide is a companion to an easy-to-use model legal template, free to download onwww.uk.coop/simplybuyout

Business owners and employees want to read abouthow employee owned businesses work in reality.erefore throughout this guide we make reference toa number of successful employee owned businessesand highlight their ownership structure, governancesystems and how they embed co-operative principlesin these areas.

ese businesses are:

School Trends supplies school uniforms toprimary and secondary schools across the UK.e company is based in Sheffield and has 120employee owners.

PrimePac Solutions is a contract packagingcompany based in South Wales that fills bottles,sachets and tubes for clients, including leadingbrands in the health and personal care sector.

West Highland Free Press, based on the Isle ofSkye, has been a successful Scottish regionalpaper for over 40 years, playing a much valuedrole in the communities it serves.


Employee ownership normally occurs as a result of abusiness owner selling their shareholding to theemployees and, although less common, there have alsobeen cases where a business owner has gifted theirownership stake in the business to their employees.

e number of employee owned businesses in the UKis increasing. In 2009 these businesses accounted foraround £25 billion of the UK economy, or equal to2.5 per cent of Gross Domestic Product (GDP). In2012 it was estimated that these numbers had risen toaround £30 billion and 3 per cent of GDP.

ere isn’t a definitive definition of employeeownership that is universally recognised and accepted.Different businesses, trade bodies and politicians mayhave a slightly different definition. However, employeeownership is regularly defined as those businesseswhere employees own a significant stake in thebusiness that they work for.

is definition takes in wholly employee ownedbusinesses like Arup and Suma Wholefoods all theway through to Sainsbury’s PLC and Sports DirectPLC which operate employee shares schemes (see part2.2) where employees own a minority stake.

ere is nothing necessarily wrong with the definitionabove, or the position taken by different businessesand individuals. However, it doesn’t require thatemployees own, at least, a controlling stake in thebusiness (over 51 per cent), nor does it ensure thatemployees have a significant degree of influence overthe business. is is something that the co-operative

sector believes is central to the notion of employeesowning their business and draws a clear distinctionbetween employee ownership and employee shareschemes. e former is about employees owning theirbusiness and ensuring that it ultimately operates forthe long-term benefit of employees now and in thefuture, whereas the latter can often be simply a formof enhanced remuneration without any influence overthe business.

is guide is written for those interested in creatingemployee owned businesses where employees own atleast a controlling stake, not for those looking toincorporate enhanced remuneration schemes.

For the purpose of this guide we define co-operativeemployee ownership as:

‘A business that operates primarily for the benefitof all of its employees, that involves them in keydecision making and that is owned by them, ideallyin whole or, failing that, with a majority stake.’

We can break this definition down as follows:

‘Operates primarily for the benefit of all of itsemployees’ – the business should operate for thebenefit of all employees, not just for a select few. ebusiness needs to be commercially viable, but profit atthe expense of everything else is not the sole driver.e purpose of the business is to provide employmentopportunities now and in the future, good terms andconditions, opportunities to share in the profitsgenerated and to do good in society.


1.1 What is employee ownership?ere are many successful employee owned businesses in the UKoperating across a spectrum of industries. ey range from largebusinesses such as the John Lewis Partnership with more than84,000 ‘partners’ to smaller businesses such as Ecosulis with 13employees – and of course pretty much any size in between.

1. What is employee ownershipand why choose it?

‘Involves employees in key decision making’ – forthe avoidance of doubt we are not advocating thatemployees should be involved in every single decisionthat is made! What we do advocate is that decisionsshould be pushed down the organisation as far aspossible and employees should be consulted on keydecisions that will affect them and the future of their business.

‘Owned by employees in whole or with a majoritystake’ – as a co-operative, the business should be atleast 51% owned and controlled by the employees, orbe working towards this via a phased sale to employees.Anything less than this means that ultimately thepurpose and long term future of the business mightnot be aligned with the employees’ interests.

e co-operative dimension helps to ensure that abusiness is not just owned but is also ultimatelycontrolled by employees.

1.2 e routes to employee ownership

ere is a variety of different situations that mightresult in people exploring the possibility of becomingemployee owned. is guide focuses on employeeownership as a result of a business succession scenarioas outlined below.

1.2.1 Business succession

Most business owners recognise that one day they willwant, or need, to withdraw or retire from theirbusiness. Businesses owned by a small number ofpeople may find business partners want, or need, toexit the business. Family owned businesses mightstruggle to pass on the business to the next generation.In any of these situations it makes sense to plan forthese types of eventuality rather than become a victimof circumstance and unplanned consequences.

Business succession can often be categorised as follows:

Retirement – where a business is privately owned,the sole or principal shareholder may be nearingretirement and may want to sell their stake in thebusiness. An increasing number of business ownersare concerned about whom they sell their businessto, especially if they want to maintain theindependence of the business and ensure it doesn’tdeteriorate and jeopardise employees’ jobs. For someowners the prospect of selling to a competitor withwhom they’ve competed for a number of years is

not attractive. e sale of the business to employeesprotects the workforce, maintains its independence,keeps the business in the community and ensuresthat the name above the door need not change.

Family business – recent studies have highlightedthat most family businesses do not continue past thesecond generation of family members. Employeebuyouts can often be seen as the best way ofensuring that the family business ethos and culturecan continue.

Realisation of investment – the current owners of abusiness may require their funds, or may not wantto continue with their investment in the business, ordue to personal circumstances might need to realisetheir value at short notice. Employees may see theunrealised potential of a business and be willing topurchase the business from the outgoing owner.

Exit of a business partner – where only one of theowners wishes to exit the business and theremaining owner is unable or unwilling to buy theshareholding available, the employees are likely tobe seen as a far better option than an unknownoutside replacement investor.

Divestment – there have been a number ofinstances where a parent business wishes to sell asubsidiary, which is not part of its core actvity orpart of its future plans, in order to obtain funds toreduce borrowings or make an investmentelsewhere, or for other strategic reasons.

If the subsidiary can continue to be a viable businessan employee buyout can ensure that jobs arepreserved and the business can continue to impacton the local economy. e reality is that thesesituations have been few and far between in the UK.

Business succession is obviously a key issue facingbusiness owners, who often see no easy way of realisingthe value built up over the years while safeguarding thejobs of longstanding and loyal employees.

Selling the tangible assets may realise only a fraction ofthe going concern value and a trade sale opens up theintimate details of business to competitors.

In most circumstances exiting business owner will beadvised to consider a trade sale, management buyoutor liquidation as their primary exit options.Professional advisors might suggest employeeownership as an option, but historically this has notbeen the case and is one the barriers to the growth ofemployee ownership amongst private business


identified by the Nuttall Review. e result is that business owners might well be making an ill informed exit decision if employee ownership has not been considered.

Liquidation – when a business is terminated or bankrupt, its assets are sold and the proceedspay creditors. Any leftovers are distributed to shareholders.

Management buyout – when a business isbought by the management team and the majorityof employees are excluded from the process.

A trade sale, management buyout or liquidationmight be a suitable solution for some business owners,but when making such an important decision wewould suggest considering the following questions tohelp determine whether these options are feasible andwill deliver the desired outcomes:

Do you really want to sell to a competitor? – doyou want to share the businesses accounts? Do youwant the name above the door to change? Do youwant the business to lose its independence?

Will the management team really be able to funda purchase? – will they be able to raise sufficientfunds to buy you out? What about the otheremployees who have not had an option to beinvolved? Does this create a sound platform for thefuture of the business?

Is secure employment for your longstanding andloyal employees important? – will a trade saleultimately result in the business being stripped back,with roles consolidated and job losses? Will amanagement buyout ultimately lead to a futuretrade sale?

Is continuity of the business important? – if youhave spent years building up the business do youreally want to shut the doors? Would a liquidationof the assets realise anything like the value of thebusiness as a going concern?

Do you want the value and commitment to thelocal community to disappear? – a trade sale willoccur where an external party sees value in yourbusiness either now or in the future and thefeasibility of many trade sales is based on the costssavings to be found by removing duplication offunctions and people.

In addition to these questions it is advisable toconsider the respective benefits and shortfalls that areassociated with these exit options.

Earn out – when a payment to shareholdersselling their shares in a company is contingenton the achievement of certain performancecriteria (e.g. company profits) over a specifiedperiod after the closing of the sale.


Shut down/liquidate

Benefits

Quick and easy

Know what the resulting business is worth

Not reliant on waiting for payments spread over a number of years

Shortfalls

Normally the last resort option

Could be the lowest return

No desire to see employees benefit

No legacy

No continuity for customers/suppliers

Jobs lost from local economy

Redundancy and other costs associated withliquidation often underestimated


Management buyout

Benefits

Positive if the management team has the required skills

Gain for managers

e management team should understand thebusiness

Does not have to open up books to competition

Job continuity likely for all/most

Owner could retain an interest in the business

Owner gets a reasonable price

Increased loyalty of managers

Continuity for suppliers and customers

Shortfalls

Benefits the few managers, not the many employees

Burden of debt secured against the company, butbenefits only management owners

Concern if management team doesn’t have the skills

Only delays the succession issue (managers will want to sell once they have increased the value)

Non-management employees’ contribution notrecognised/rewarded

Trade sale (traditionally the most common option)

Benefits

Owner gets the best price (highest bidder) and can exit

Incentive for the owner to get the business in thebest possible shape

Can be positive in terms of growth opportunities ifa ‘good’ takeover with synergistic opportunities

Shortfalls

Could be a longer process than other options (due diligence, price negotiation, etc)

Little protection for employees as cost savingsidentified and job losses more than likely

Could require relocation of business

No heritage guarantee (business could be wound up or rebranded)

Opens up books to the competition

Business might be bought solely to asset strip

If business closed down, owner may be perceivednegatively in the community and remaining therecould be uncomfortable

Employees who helped grow the business are unlikelyto benefit in any way

Could require continued involvement of owner if‘earn out’ is included

Some business owners will of course still opt for atrade sale, management buyout or liquidation.However, the statistics show that an increasingnumber of entrepreneurs, business partners and familyowners wish to retain what is unique, distinctive andvaluable about their business and have been persuadedto choose the employee ownership option becausethey have been made aware of the numerous benefitsthat an employee buyout could deliver.

Although this guide focuses predominantly on abusiness succession scenario the following are alsoroutes to becoming employee owned:

1.2.2 As an engagement mechanism – some businessowners have embraced widespread employeeownership of the business as they believe it will lead togreater levels of engagement and this will ultimatelylead to productivity and performance gains.

Some business owners have adopted this approach as a‘starter/feeder’ mechanism to becoming fullyemployee owned over the longer term. In thesescenarios a small percentage of ownership is initiallyshared by all employees on the basis that the ownerwill sell the remainder of the business at a later stagewhen the value of the business has increased as a resultof all employees having a vested interest in seeing thebusiness grow.

1.2.3 Business in distress – a poorly performingbusiness may be threatened with closure by its currentowners to prevent further losses. In order to save theirjobs, the employees could buy the business from thecurrent owners.

is is a high risk situation and it would not beadvised unless a viable business proposition has beenidentified and there is evidence of why an employeeowned business would succeed where others hadfailed. A useful start point is to read Saving Businessthrough Worker Co-operatives by Dr Anthony Jensen.iv

1.2.4 Public service mutuals – in the currenteconomic climate the UK government has sought tomove out some public sector departments and servicesto the private sector with the intention of allowingsome form of employee ownership as an option. isguide is aimed at encouraging private sectortransitions; however more information about settingup a public service mutual can be accessed throughthe Mutual Information Service.http://mutuals.cabinetoffice.gov.uk/


Employee owned

Benefits

No negative effect on local economy through loss of business/jobs

Continuity for customers and supplier

Owner can secure fair price

Books (accounts) not shown to competition

Some tax benefits

Loyal employees gain secure employment

Owner perceived highly in the community

Owner can retain a role in the business

Business can take long term decisions as less dependent on external investors

Owner can gradually exit over time as agreed with employees

Shortfalls

Payment might be spread over a number of years

Burden of debt on the business

e business may not have the necessary skills ifthe owners step away

Might be the need for a significant culture shiftif the owner has been autocratic

School Trends became an employee ownedbusiness in 2004 when the founder ownerdecided that he wanted to consider his exitoptions. A key consideration for the owner wasthat he wanted the business to continue tooperate with the community type ethos andculture that had been developed, wanting theemployees to benefit from the futureopportunities open to School Trends and notwanting to sell out to a competitor. Anemployee buyout was the obvious choice toachieve his objectives. Employees were consultedon the possibility of an employee buyout and aballot was held, with over 80 per cent of theemployees voting in favour.

PrimePac Solutions was formed whenBudelpack decided to withdraw from Walesfollowing a fire, which destroyed its packingfacilities. Having been inspired by the famousnearby Tower Colliery buyout where 250 minersbought the pit from the National Coal Board,19 former Budelpack employees used theirredundancy payments to form PrimePac andbuy machinery in order to resume trading.

West Highland Free Press moved to employeeownership in 2009 when the original foundersand shareholders looked for an exit strategy asthey reached retirement age. e owners werekeen to ensure that the paper remainedindependent and offered the employees theoption of purchasing the business. However, hadthe employee buyout not been completed, thereality is that a trade sale would have beenchosen and the paper would have lost itsindependence and place in the community.

1.3 e benefits of employee ownership

Businesses across the UK wrestle daily with thechallenge of ‘engaging’ employees. Most businessleaders accept and agree that the financial success of abusiness relies on the wholehearted participation anddiscretionary effort of their employees. e mostsuccessful businesses are those that devise strategiesand tactics that encourage employees to actively go

about creating value rather than passively following others.

ere are many tried and tested tactics implementedto drive ‘engagement’ that result in employees ‘goingthe extra mile’ and feeling positive about the role theyplay within the organisation. e reality though is thatthe wealth generated as a result of this going the extramile in the main flows to somebody else rather thanthe employees and they become acutely aware of this.

Employee ownership presents a ‘win-win’ opportunityfor everyone involved in a business, the logic beingthat employees with an ownership interest will bemore motivated and committed to producingsuccessful outcomes. If this is combined with a cultureof engagement where employees are treated withrespect and involved in appropriate levels of decisionmaking, the business becomes more productive,competitive and entrepreneurial. Employees share inthe benefits resulting from the use of their talents andenergy, so going the extra mile is now in their interestsas owners which in turn will help the businessoutperform its competitors.

e ever increasing body of research providescompelling evidence that employee ownershipprovides a range of benefits to the business,individuals and the macro economy.

Academic studiesv have associated employeeownership with higher productivity levels comparedto companies without employee ownership.

Employee owned businesses with fewer than 75employees performed better on profitability comparedto non-employee owned companies.vi is issignificant when you consider that the Office forNational Statistics reported that of the 2.08 millionenterprises registered for PAYE and VAT 98 per centof these had fewer than 50 employees.

Employee owned businesses tend to be moresustainable (less likely to fail than traditionally ownedbusinesses) and are able to take a longer term view asthere are no external shareholders requiring short termreturns. In times of recession, employee ownedbusinesses are shown to outperform traditionallyowned businesses. Research from the Cass BusinessSchool found that their performance over the businesslife cycle is more stable and sales growth between2008 and 2009 was 11.8 per cent for employee ownedbusinesses compared to 0.61 per cent for non-employee owned businesses.


e Employee Ownership Index (EOI), compiled byField Fisher Waterhouse LLP, is an index of the shareprices of UK public companies quoted on the LondonStock Exchange and AIM that have 10 per cent ormore of their issued share capital held by or on behalfof employees other than main board directors. eEOI started in 1992 and shows that, despite the dropin performance seen in 2011, employee ownedbusinesses have outperformed FTSE All-Sharecompanies by on average 12 per cent each year. Oversuccessive three-year periods they have outperformedby 37 per cent and over successive five-year periods by71 per cent.

Employee owned businesses that combine shareownership and employee involvement report veryhigh levels of employee engagement, employeecommitment and retention and low levels ofabsenteeism. e Sunday Times Top 100 Companies ToWork For included a number of employee ownedbusinesses such as Lindum and Childbase. eMacleod Review of employee engagement, the mostsignificant review of employee engagement in the UK,found that “employee ownership was a profound anddistinctive enabler of high engagement”.

Employee owned businesses benefit the communitiesthey operate in because the rewards are shared amongthe people who work within the business rather thangoing to a single owner or external shareholder, as isthe case in more traditional structures.



Direct ownership – individual employees directlyown shares in the business they work for. isownership may have been facilitated throughemployees purchasing shares using tax advantagedshare schemes.

Indirect ownership – an employee trust owns sharesin the business on behalf of beneficiaries. ebeneficiaries of the employee trust are the existingemployees, past employees and future employees. eemployee trust holds these shares with no intention ofever selling them and any benefit derived fromholding them is solely for the beneficiaries.

Hybrid ownership – a mixture of both direct andindirect ownership – ie individual employees directlyown shares and an employee trust also owns shares.

It is important to remember that there is no ‘right’ or‘wrong’ employee ownership model and ultimatelybusinesses will choose different models to achievedifferent objectives.

It is worth considering the key differences betweendirect and indirect ownership before making anydecisions on how to structure an employee buyout.

2.2 Direct ownership

e direct ownership model allows employees tobecome shareholders in the business they work for.One of the compelling arguments for directownership is that owning a tangible personal stakemight make ownership feel ‘real’ when compared toan employee owned business owned indirectlythrough an employee trust.

As a shareholder, employees are able to influence keydecisions that affect their business such as appointingand removing directors, any sale of the business or itssubsidiaries, any acquisitions of other businesses orjoint ventures, etc. e governing documents for the

2.1 e different types of employee ownership modelsAn employee owned business can be structured in a number ofways. However, most will normally choose direct, indirect, or ahybrid models of ownership.

2. Choosing an employeeownership model andconsidering methods ofgovernance

AnyCo Ltd5%

7%

5%

5%

5% 5%

5%

3%

5%

5%

5%

5%

Direct ownership

5%5%2%5%

5%

8%

5%5%

business will determine what types of decisions needto be referred for shareholder consent.

In addition to being able to influence the business,employee shareholders also have the opportunity tobenefit directly from its successes. is benefit isnormally through dividends (which are more taxefficient than cash bonuses) and an increase in sharevalue. When an employee leaves the business theyown shares that they can offer for sale and realise thevalue they have helped to create over the years.

However, like any other investment, should thebusiness not be successful employee shareholders carry the risk of their investment losing value andpotentially becoming worthless should the business fail.

e direct ownership model occurs in buyoutscenarios where employees purchase shares from theoutgoing owner.

e shares purchased would normally be OrdinaryShares issued on a one-person one-vote basis,irrespective of the number of shares purchased. It isnormal to have a shareholding limit written into theCompany’s Articles of Association so that, forexample, no employee can have more than 5 per cent

of the total issued share capital. is ensures a spreadof ownership and prevents a block of shares being heldby a small number of employees who might developdifferent objectives and agendas.

e benefits and potential shortfalls of directownership are summarised in the table below.

In most cases it will not be possible for employees toraise sufficient funds to purchase all of the shares froman outgoing owner and therefore the opportunities fora direct ownership model are limited.

When PrimePac Solutions was originallyformed in 2005 it was directly owned by the 19employees who each purchased shares to fundthe formation of the business. e employeesagreed that they would each purchase an equalnumber of shares so that there was no potentialfor people to build up a disproportionate stakeand want to have more influence. After achallenging start PrimePac has been verysuccessful and employees have benefited fromdividends in excess of their original investment,alongside an increase in the value of their shares.


Direct ownership

Benefits

Able to influence/control the business

Right to dividends based on number of shares held byeach shareholder

Right to attend the annual general meeting (AGM) orgeneral meetings (GM) and vote on key decisions thatwill affect the business

If the business is successful, shareholders have thepotential of seeing this reflected in the share price

Shareholders share in the capital of the business if it is wound up

Potential shortfalls

At some point shareholders will want to sell. Needssome form of market for the shares

Limited market if only other purchaser is fellowemployees who may already have enough shares

If the business wants to fund the purchase this willimpact on cash as the money will need to be foundfrom within the business’s own funds

New employees who join and contribute to thesuccess may not be able to buy shares if existingholders do not want to sell and will not agree to newshares being allotted

Value of investment could of course drop if thebusiness isn’t successful

2.2.1 Direct ownership facilitated through HMRCapproved share schemes

Many of the employee owned businesses in the UKoperate employee share schemes. Different commercialor cultural reasons will have a bearing on whichemployee share schemes are implemented. Employeeshare schemes are normally implemented for thefollowing reasons:

ey facilitate employees owning shares and givetangible ownership in the business;

ey align the employees’ interests with that of thebusiness through share ownership;

Employees are encouraged to think, feel and act likeowners through linking between better businessoutcomes and performance to increased share valueand dividends for individuals;

ey attract, retain and motivate employees;

ere are possible significant tax savings for boththe business and employee while offering long termreward.

It is vital that when determining the employeeownership structure and detail of the employeebuyout that consideration is given to these reasonsbefore deciding on whether or not to implement an employee share scheme.

2.2.2 What are the options?

Employee share schemes can be structured toincorporate all, or a mix, of the following three main aspects:

A gift of shares – an employee immediatelybecomes a shareholder as a result of being ‘gifted’shares, free of charge, in the business they work for.As a shareholder the employee can then benefitfrom any dividends and any increase in the sharevalue. However, in most instances where anemployee is given something of monetary value,such as shares, by their employer this will be treatedas a benefit in kind. As such the employee will besubject to income tax and National Insurancecontributions and the business will be subject toemployer’s National Insurance contributions.

Employee share purchase schemes – thesefacilitate employees buying shares from thecompany, share incentive plan, or employee benefittrust. Again, the benefit of an employee owningshares is through dividends and any increase in the

share value.

Share options – this gives an employee the right topurchase shares in the business at some future pointat a predetermined price. ere is no risk, orbenefit, for the employee until the shares arebought. If the price increases the employee exercisesthe option: if the price decreases the employee candecide not to exercise the option.

ere are HMRC tax advantaged share schemes (seebelow) that incorporate the above options and make it easier for employees to acquire and own thebusiness’s shares.

2.2.3 Tax advantaged share schemes

ere are currently four HMRC approved taxadvantaged share schemes that might be considered bya business:

Share Incentive Plan (SIP) – offers tax andNational Insurance advantages for employee giftedand purchased shares.

Save As You Earn (SAYE) share option scheme –employee share ownership via options.

Enterprise Management Incentive (EMI) – an option scheme designed to help smallerbusinesses retain talent.

Company Share Option Plan (CSOP) – allowsoptions to be granted to selected senior employees.

As the primary purpose of this guide is to encouragethe transfer to employee ownership as a result of anemployee buyout we focus on the Share IncentivePlan (SIP) as it is the only tax advantaged sharescheme that allows for the purchase of shares.

A number of employee owned businesses use a SIP to encourage direct share ownership. A SIP is basically a trust, designed by HMRC, to encouragethe direct ownership of shares by employees in a tax-efficient way.

e SIP is an ‘all employee’ scheme and the legislationprovides for four main types of plan shares to be used.ey are:

Free shares – each employee can receive ‘free’ sharesworth up to £3,000 each tax year;

Partnership shares – employees can use their pre-tax and pre-National Insurance contributions salaryto purchase up to £1,500 of shares each tax year;


Matching shares – employers can give matchingshares at a ratio of up to two matching shares foreach partnership share bought by employees;

Dividend shares – employees can use the dividendsreceived from their other plan shares to purchasemore shares through the SIP.

A SIP can be used to facilitate the purchase of sharesin a buyout situation by providing a tax effective routeto encourage direct shareholding, but the limit of£1,500 for partnership shares means that using a SIPalone is unlikely to result in a buyout beingcompleted.

As financial reward is through dividendpayments, PrimePac Solutions installed a SIP in2012 to encourage those employees without anyshares to directly purchase shares in the businessin a tax efficient manner. As the SIP is an allemployee scheme all employees were given theopportunity to participate. e SIP was chosenas it allowed employees to purchase sharesthrough monthly deductions from their grosssalary, before deductions for PAYE and NationalInsurance contributions, rather than require alump sum payment for the value of the shares.

School Trends is in the process of installing aSIP. Although all employees already own sharesin the business it is hoped that offering amethod to receive shares in a tax advantaged waywill encourage employees to build up theirshareholding.

2.3 Indirect ownership

An employee trust owns shares in the business onbehalf of beneficiaries. e beneficiaries of theemployee trust are the existing employees, pastemployees and future employees. e employee trustholds these shares with no intention of selling themand any benefit derived from holding these shares issolely for the beneficiaries. One of the compellingarguments for indirect ownership is that it ensureslong term stable employee ownership because theshares in the trust don’t need to be sold again, whereasshares held directly by employees will be regularly soldwhen employees leave the business and this needs tobe financed.

Trustees manage the employee trust and a ‘trust deed’details the purpose of the employee trust and thepower and duties of the trustees in managing theaffairs of the employee trust. e key duty of trusteesis to act in the best interests of the beneficiaries. etrustees take on the role of shareholder and are able toinfluence key decisions that affect the business such asappointing and removing directors, any sale of thebusiness or its subsidiaries, any acquisitions of otherbusinesses or joint ventures.

Trust deed – a legal document that sets out thepowers and duties of the trustee. An exampletrust deed can be downloaded fromwww.uk.coop/simplybuyout as part of themodel rules.

Employees are beneficiaries of the employee trust, notdirect shareholders, therefore they have no right toany dividend, nor do they own shares they can sellwhen they leave the business in order to realise thevalue they’ve helped to create.

e employee trust is discretionary, allowing thetrustees wide scope in deciding how benefit should beallocated to beneficiaries. For a vast majority ofemployee owned businesses using a trust this benefitmight simply be a cash bonus paid to all employees inlieu of the employee trust receiving its dividend. iscash bonus would attract the normal PAYE andNational Insurance contributions deductions.

e John Lewis Partnership is probably the bestknown example of an employee owned business withan indirect only ownership model. e 39 John Lewis


EBT 100%

AnyCo Ltd

Employees

Indirect ownership

stores and 291 Waitrose supermarkets are owned by atrust on behalf of the 84,500 John Lewis partners. In2013 John Lewis announced that the partnershipbonus payable to ‘partners’ was equivalent to nineweeks’ worth of salary. In addition to these financialbenefits ‘partners’ also benefit from discounts on theirpurchases from the department stores andsupermarkets, a range of ticket subsidies and holidayand leisure facilities.

2.4 Hybrid ownership

is is a combination of direct and indirectownership. For example, 80 per cent of the sharescould be held by the employee trust, with the restdirectly owned by the employees. ere are no fixedproportions for this shareholding split.

e compelling argument in favour of the hybridmodel of ownership is that it combines the variousbenefits of both direct and indirect ownership whilereducing their respective shortfalls.

e shares held by the employee trust can be‘warehoused’ for the long term to ensure that thebusiness runs for the benefit of its employees.

e shares held directly by employees will allow themto receive dividends, share in any increase in value of


Indirect ownership

Benefits

A key attraction is that the business can be run forthe benefit of the employees for the long term asthe employee trust would never need to sell theshares and it would be established with the purposeof ensuring that the business is run for the benefitof the employee owners

It would be possible to enshrine some principles andguidelines into the trust deed to guide the trustees toensure that the business operates in a certain manner

As nobody other than the employee trust would ownshares there is no requirement to find money to buyshares when employees leave

As the shareholder the employee trust could receivedividends and pay these to employees as a bonus, orsimply waive their right to dividend and let thebusiness use the waived dividend to pay a cash bonus

e employee trust is a discretionary trust so thetrustees can determine how they want employees tobenefit from time to time


e employees are not direct shareholders – they are simply beneficiaries – and as such have no legalright to attend and vote at the AGM or any general meetings

e employees would have no legal right to anydividends, as they are not direct shareholders. Anydividends would be received by the employee trustwho may decide not to distribute them to theemployees

If the value of the business increases the employeeswill not benefit from this as they don’t directly ownshares that could have increased in value

Bonuses paid via the employee trust will be taxinefficient and additionally the employees would beliable for PAYE and National Insurance contributionson any bonuses they receive from the trust

AnyCo Ltd

Hybrid ownership

EBT 75%

SIP10%

1%

1%1%

1%

1%

1%

1%

1%

1%

1%

1%

1%

1%

1%1%

the business and allow employees to influence thebusiness through the voting rights attached to theshares.

As with the direct model there is still a need to financethe purchase of shares from employees when theyleave the business, but if the vast majority of shares areheld by the employee trust the purchase of a minorityof shares will be easier to finance. e employee trustcan act as a ‘market maker’ and purchase shares fromoutgoing employees and sell shares to new employees.

West Highland Free Press has a hybrid modelwhereby 85 per cent of the business is indirectlyowned through an employee benefit trust onbehalf of employees and this ensures that thebusiness can remain forever employee owned.e employees as individuals own the remaining15 per cent of the business and will be able tobenefit from any increase in value of the businessin the future.

School Trends has a hybrid model. AnEmployee Benefit Trust owns around 95 percent of the business with the remaining sharesowned directly by employees. A SIP has recentlybeen installed to encourage employees to directlyown more shares. To ensure future employeeownership, the employee benefit trust’sshareholding cannot fall below 50.1 per cent.

PrimePac Solutions has a hybrid model. It hasshares held directly by employees and indirectlythrough an employee benefit trust and through aSIP. Unlike School Trends and West HighlandFree Press the vast majority of shares are owneddirectly by employees because PrimePac believesthat employees should benefit directly throughowning shares. An employee benefit trust wasinstalled in 2012 in order to act as a ‘marketmaker’ and purchase shares from employeeswhen they leave.


Hybrid ownership

Benefits

e majority of shares can be held in the employeetrust to secure long term employee ownership

e minority of shares can be held directly byemployees, giving them the legal right to attendAGMs, receive dividends and benefit from anyincrease in the value of the business

An employee trust can act as a ‘market maker’ andpurchase shares from employees who leave (subject to it receiving ‘gifts’ from the business)

e employee trust could sell shares to newemployees.

e employee trust could still waive its dividend andthe other shareholders could share the dividend pot


Depending on the voting structure of the business theemployee trust may be able to determine the outcomeof all key decisions – which might be seen byemployees as undemocratic

e employee trust doesn’t normally receive anyincome. erefore it is reliant on the company toprovide funds to allow it to purchase shares

Management and administration are linked to managing the employee benefit trust and any sharescheme (compared to direct ownership)

2.5 Methods of governance

An essential ingredient of co-operative employeeownership is ensuring effective employee voice andgovernance. Employees should have a right toparticipate in the governance and, where appropriate,management of their business. ey should have easyaccess to relevant information relating to the success,or otherwise, of the business that they own.

ere are no ‘right or wrong’ methods of governanceand businesses will be influenced by their individualobjectives and circumstances when determining whatmethods to implement. However, it is important thatsome form of mechanism is put in place to ensure:

at there is some form of representation ordemocratic voice for employees at board level;

at employees are able to hold the board of thedirectors to account for the running of the business,either directly or indirectly through elected trustees;

at employees are encouraged to improve thebusiness and play their part in identifying andimplementing suggestions;

at there is a regular flow of relevant information,delivered in a way that employees understand,relating to the progress the business is making inrelation to its stated objectives.

Employee owned business use a variety of methods toprovide governance and employee voice. ese mayinclude:

2.5.1 Employee directors

Employees elect a fellow (often non-management)employee to become a director of the business. epurpose of this position is to provide the board withan employee perspective to aid its discussions anddecisions. is means they work with the board toensure that employee views are taken into account atall decision making levels – strategic, operational andtactical. is role can also help to maintain openchannels of communication with the employees tohelp foster better understanding of views andconcerns. e employee elected director has the samelegal duties as other directors and their first andforemost responsibility is to the business.

2.5.2 Employee trustees

If an employee owned business has either an employeebenefit trust or SIP it will require trustees to managethe affairs of these trusts. Employees elect a fellow(often non-management) employee to become atrustee. e role of the trustees is to manage the affairsof the employee benefit trust and hold shares in thebusiness and act in the best interest of beneficiaries.e employee elected trustee works with other trustees(for example an appointed and an independenttrustee) to hold the board of the trading business toaccount and ensure that the business is being run as asuccessful employee owned business. e trustees do


Trustees

Board of Directors

Senior Management

Employees

EmployeeOwnershipCouncil

Trustees in their capacity as shareholders hole theBoard of Directors to account for its managementof the company as an employee owned business

The Board of Directors is responsible for settingand delivery the strategy of the business andensuring performance targets

The senior management team ensures thatoperational activities are completed and leadteams/departments of employees

Employees elect fellow employees to any of:• Employee Ownership Council• Board of Directors• Trustees

The Employee Ownership Council acts as theconduit between employees and the Board ofDirectors


not run the company and therefore should not try tointerfere with how the board run the business.

2.5.3 Employee ownership council

Employees are elected to some form of representativebody. is body might for example act as a conduitbetween the employees and their board and may havea remit to act in the best interests of the employees.

Ultimately it is up to the business to decide whattypes of governance it wishes to include. Someemployee owned businesses use all of the abovegovernance methods, whereas some may operate only one method.

PrimePac Solutions doesn’t specifically requireemployee elected directors as part of its Board,but it does allow any employee members to putthemselves forward to be appointed to the Boardat the AGM of the business.

West Highland Free Press elects threeemployees to the Board and they play an activerole in helping to develop the business bothcommercially and culturally.

School Trends operates a ‘governing council’comprised of four elected employees. egoverning council remit is to “work with theBoard in a participative style to keep thebusiness strong and in employee ownership”.e governing council is involved indetermining the social impact of future strategyand policy and any changes to terms andconditions of employment need to be agreed bythem. e governing council elect two of itsnumber to the Board and also to the Board thatcontrols their employee benefit trust and SIP.


Worker co-operatives are a form of employeeowned business that operate with specificcommitments to democratic practices. eircode of good governance can be found here:www.uk.coop/workercode

3.1 Voluntary and open membership

An employee owned business functions best as aninclusive team of members with long-term collectiveinterests in the success of the business.

Membership must be open to all employees who areable and willing to accept the responsibilities ofmembership. Membership must be voluntary andmight require that employees complete a probationaryperiod before being eligible to apply for membership.

School Trends requires that employees purchasea minimum number of shares (5 per cent ofannual salary) as a condition of employment.New employees have 12 months to purchaseshares, but this purchase of shares is a non-negotiable condition of employment.

At PrimePac Solutions employees must have completed a period of 12 months’continuous employment (either full or parttime) before they are eligible to purchase sharesin the business.

10 of the 15 employees of West Highland FreePress raised 15 per cent of the money requiredto complete their employee buyout. Withoutthis show of commitment from the employeesthe buyout would not have been completed.

It is vital that employees understand how theownership structure works and why it should bebeneficial to them, their colleagues and the widercommunity. Additionally, there should be an agreedset of responsibilities that all members understand andadhere to. Being an owner is about sharing the risksand benefits; not just the benefits!

School Trends ensures that prospectiveemployees understand the ownership structureof the company by covering this as part of therecruitment process. Additionally, on joining thecompany employees take part in a thoroughinduction process that details the ‘rights andresponsibilities’ of being an employee owner.

Co-operative and mutual considerationsCo-operative employee owned businesses come in many forms,but underpinning these, in the UK and around the world, theretends to be a common set of values and principles. ey applythe values of co-operation – such as democracy, equality andsolidarity – in the way that they work. ey are also aligned witha number of key principles. ese key principles and examples ofhow they can be put into practice, for illustrative purposes, aredescribed below.

3. A co-operative dimension


3.2 Democratic member control

Employee owned businesses are democraticorganisations controlled by their members, who also set policy and make key decisions. esebusinesses succeed when employees activelyparticipate in transparent and fair decision makingand long term planning.

A core aspect of democratic control is that key'governance' decisions are decided on the basis of ‘oneperson one vote’ regardless of the number of shares anindividual employee might own. Operating in aninclusive way makes for a different kind of workplace,but it is misconception to assume that this makes forslow decision making. Giving people some form of asay in relation to big strategic decisions can make allthe day to day decisions that follow easier to apply.

People take more of a responsibility for decisions ifthey have had a say in how they have been reached.Leadership in a co-operative employee ownedbusiness, in turn, can be more effective, because thereis a mandate on where to lead … and where to follow.

e application of this principle varies betweenemployee owned businesses.

PrimePac Solutions applies this principle for allkey decisions. Even though the employee benefittrust owns over 25 per cent of the business’sshares the trustees still only have a single voteand as such are treated in exactly the same wayas any other employee member of PrimePacwhen it comes to determining key decisions.is approach is written into the articles ofassociation. erefore, any key decisions thatrequire shareholder consent are determined bythe employees in a democratic manner.

At West Highland Free Press, the trustees are ineffect able to cast 50 per cent of the vote on anydecisions that require shareholders to vote.However, the trustees have taken an approachthat they will back the majority decision unlessthey believe that to do so would not be in thebest interests of the business. e reality is thatsince the employee buyout all decisionsrequiring shareholder approval have beendetermined by a unanimous decision.

Effective communication is essential and agreementmust be sought to determine those individuals whowill have delegated authority to act on behalf of thebusiness in the same manner as any conventionallymanaged business.

It is vital that everyone understands how key decisionsare made and how employees are able to exercise theirinfluence in these decisions. Employees also need tounderstand how the management and governancefunctions work, how accountability works and therole of any elected representatives.

e Articles of Association allow the directors ofSchool Trends to make most key strategicdecisions without needing to gain the consent ofemployees. However, School Trends wantsemployees to be able to directly influence keydecisions and as a result holds a ballot ofemployees to determine the outcome of keydecisions. e most recent example of this waswhen the business was considering whether topurchase the building it operates from. A ballotof the employees was held, with over 60 per centvoting in favour of purchasing the building.

Decision making related to day to day operationsshould be pushed as far down the organisation aspossible on the basis that employees with a vestedinterest in the businesses success will want to find thebest ways of completing actions.

3.3 Member economic participation

e primary objective of any employee ownedbusiness is to operate for the benefit of the employees.erefore the business should aim to offer pay andbenefits sufficient to sustain long term employmentand membership, to enable the business to attract andretain the required skills and experience.

Employee owners don’t bite the hand that feeds them and while they might want to share in theprofits of the business, they will also want to ensure a sustainable business that operates with a long term vision.


School Trends is a seasonal business and istypically very busy through the summer months.e business has historically relied on usingtemporary staff to cope with the additionaldemand, but this has required using an overdraftfacility to cover the additional costs, particularlyfor building stocks for that busy period.Following the economic crash of 2008/9, SchoolTrends asked employees for ideas to generatesavings. Among the 200-odd ideas was asuggestion that, rather than employ temporarystaff to cover the additional summer demand,employees would work five extra hours per weekfor free. Over 98 per cent of employees agreed(within a day of sharing the idea) with thissuggestion, saving the business over £70,000.Overall, all of the cost saving initiatives thatwere implemented saved the business £800,000.

Where employees have individually invested in thebusiness there should be clarity around how theymight benefit from this investment in both the shortand long term.

At PrimePac Solutions the directors have givenconsideration to how profits will be splitbetween reward for shareholders and ensuringthe sustainability and growth of the business.

Sharing of profit should be fair and equitable betweenemployee owners, relative to their contribution.

3.4 Autonomy and independence

Employee owned businesses should be controlled andinfluenced by the employees not by externalindividuals who might have conflicting aims andobjectives. If there is a need to raise external financethis should not be at the expenses of this autonomy.

Like any other successful business it is essential thatgood financial and management controls are in placeand appropriate employees actively manage keyaspects of the business.

Being aware of internal and external risks will mitigatechallenges and possibly provide opportunities to takeadvantage of business opportunities.

3.5 Education, training and information

Employee owned businesses provide education andtraining for employees so that they are able tocontribute effectively to the development of thebusiness and appreciate the benefits of the employeeowned structure. ey also ensure that employeeowners are regularly kept informed about theirbusiness. is approach ensures that employeesunderstand their business and in terms of theownership model are better able to inform the generalpublic of the nature and benefits of employeeownership.

West Highland Free Press has embraced theidea of sharing relevant information with itsemployee owners. Every month a meeting withall employees is held and the business’s financesand cash flow are discussed, minutes from theprevious Board meeting are shared andemployees are encouraged to question any aspectof the business they are unclear about.

PrimePac Solutions holds regular briefingsessions with employees to ensure that everyoneis aware of what is happening within thebusiness in terms of sales, financial results andany other relevant information such as changesto policy.

School Trends operates a monthly ‘policy and‘nformation’ meeting and also has ‘actiongroups’. ese meetings cover all employees andare used to share information and also togenerate ideas about how teams can improvetheir parts of the business. Additionally, SchoolTrends make sure that employees feel valued. Arecent award night held to celebrate the effortsof their employees was attended by 123 of thepossible 124 employees.

It is essential that the business assesses the technical,management and co-operative skills needed to achievelong-terms plans and ensure replacements foremployees who retire or leave.

Alongside education and training related to therunning of the business, it is also essential thatemployees involved in the governance of the businessreceive training to help them fulfil their role.


3.6 Co-operation among co-operativeemployee owned businesses

A large number of employee owned businessesregularly open their doors and allow otherorganisations to learn about their business andmethods of operation. Sharing of best practice andencouraging trade between co-operative employeeowned businesses helps to widen knowledge.

School Trends regularly hosts visits from otheremployee owned businesses and also forindividuals and groups who are consideringemployee ownership.

Paul Wood, the Managing Director of West Highland Free Press, is an ‘EmployeeOwnership Ambassador’ for Co-operativeDevelopment Scotland and talks to businessowners about the benefits of employeeownership.

PrimePac Solutions’ MD, Steve Meredith, has been involved in a number of employeeownership awareness raising events organised by the Wales Co-operative Centre to promotethe business model to owners consideringsuccession.

3.7 Concern for community

Employee owned businesses tend to have strong linkswith the local community because their employees liveand work there. Building good relationships with thelocal and wider communities helps to create goodwilland gives employees an opportunity to give‘something back’.

School Trends plays an active role in its localcommunity and has been involved in a ‘right toread programme’ helping people to read, andalso supported and helped raise money for Amy’sRetreat, a charity helping families who havechildren with cancer.

West Highland Free Press has always fosteredvery strong links with its community and itscontinued independence, possible only throughemployee ownership, means that it is able tocontinue to give a voice to the local community.


An employee buyout is a complex transaction and willnormally involve a range of professional advisors suchas solicitors and accountants. Anyone consideringundertaking an employee buyout should seek advicefrom employee buyout specialists to ensure that theownership model and future of the business isdelivered as intended.

Stage 1

4.1 Establish that a buyout is in principlepossible

For any employee buyout to succeed it is essential thatthere is a business owner who wants to sell theirownership stake in the business and employees whowant to become owners of the business. At this earlystage it is important to establish some key facts to helpdetermine whether an employee buyout is feasible.

Who actually owns the business? e businessmight have a single owner, but there are manyinstances where ownership is spread across differentparties. Some business owners may have transferreda proportion of their ownership stake into a trust forfuture family generations. erefore it is imperativeto identify all of the owners of the business toensure that there is a general agreement to theconcept of selling to the employees.

What is being sold? Typically an employee buyoutwill involve either the purchase of the owner’sshares, or the purchase of the assets of the business.It is important to clarify exactly what is expected tobe included as part of the deal. For instance, somebusinesses will trade from property that is owned bythe seller individually rather than the business andthis will not be included within the sale.

Why does the owner want to sell? In most casesthe exit will be due to retirement, realisinginvestment value, a desire to do different things etc.

However, it is important to clarify the reasonsbehind the exit and ensure that the operation of thebusiness is commercially viable and has a future.

What is the attitude of management/employeesto the prospect of an employee buyout? While the business owner might be a ‘willing seller’, it isobviously important that the management andemployees of the business are open to the prospectof an employee buyout and becoming a ‘willingbuyer’.

What does the business do? Clearly it’s importantto understand what the business does, where it getscustomers from, its level of sales and profitabilityand its viability in the future.

What are the valuation assumptions? Anindependent valuation may have been undertaken,or the owner may have a value assumption based onother factors. Most valuations will be based on eitherearnings multiples, net asset value, or a mixture (seesection below). Any valuation must be affordable tothe business both at the time of the buyout andgoing forward

What is the method of exit? Realistically in thecurrent economic climate it is difficult to raisesufficient finance to allow the owner to receive thefull consideration on completion. erefore, is therethe option of a phased exit over time?

Is external finance required to complete anemployee buyout? It is quite possible that theemployees alone cannot meet the valuation of thebusiness, and that cash held in the business will not be enough. erefore there may be a need toconsider seeking external finance (see sectionbelow). e ability to raise finance will be reliant on a number of factors such as any security in thebusiness, levels of profit and possibly any co-investment by employees.

Employee buyouts provide an ideal business succession solutionand the key stages involved in achieving a successful buyout arelisted below.

4. Key stages to achieve anemployee buyout


Is there preferred employee ownership structure?Most owners will have a view of the futureownership structure of the business. However, beforeany firm decisions are made it is important thatthorough consideration has been given to ensurethat the ownership model provides the benefits thatemployees might want from becoming owners.

What are the timescales? Ideally, when would theowner like to complete the employee buyoutprocess? Typically a buyout process can takeanything between three and nine months tocomplete. If a phased transfer of ownership is beingconsidered, this transfer might take place over anumber of years.

A key consideration for the owner will be the possibletax implications associated with selling theirshareholding. is requires careful planning andprofessional advice should be sought. e UKCoalition Government has made announcements that£50 million will be made available annually toencourage owners to sell a majority shareholding to anemployee owned structure. e specific detail inrelation to this announcement is yet to be released.

Ultimately, by the end of stage 1 you should knowwhether there is a ‘willing seller and a willing buyer’. Ifyes then continue to stage 2; if no then an employeebuyout may not be the succession solution.

Assuming that the employee buyout will proceed it iswise to consider involving a small group of employeesto form a ‘buyout’ team so that they are able toinfluence decisions that will be made throughout thefollowing steps.

Stage 2

4.2 e valuation, financial analysis andprojections

Once it has been established that an employee buyoutis agreed in principle it is necessary to analyse thehistory of the business, its finances and the ability tofund the buyout price.

With a share purchase it is only the ownership thatchanges: the business itself continues, and so do anyliabilities, hidden and contingent though they may be;moreover, the value of the shares will reflect in partsuch assets as book debts, whether or not past practicehas established habits of late and disputed payment.

Methods of valuation – it is sensible to deal withthe valuation of the business at a very early stage. Ifthe valuation cannot be funded and there is no

room for negotiation then quite simply an employeebuyout will not be possible.

e two most common approaches to valuation areby reference to the assets and earnings of thebusiness:

– Net asset value – the value of the business assets(land, buildings, plant, machinery, stock, debtorsetc) minus the businesses liabilities (creditors,other long term liabilities etc) can be used as thebase for the valuation.

– Earnings basis – usually arrived at by applying amultiple to either pre-tax or post-tax previousyears’ earnings. e multiple might be calculatedby taking an average of previous years’ earnings,and/or including forecast future earnings.

Financial analysis and projections – ultimatelyany valuation has to be fundable. In order todetermine what the business can fund it is necessaryto prepare cash flow forecasts to identify what levelof borrowings the business can fund. ese cashflow forecasts will also show the impact of costs thatmight no longer be incurred, such as directors’remuneration. In addition to looking at the future itis also important to look at historic financial trendssuch as levels of turnover and profitability.

Stage 3

4.3 Considering financing options andmaking initial contacts

Once stage 2 has been completed it should be possibleto determine whether the valuation is realistic and, ofcourse, fundable. e financial analysis and futureprojections will allow for decisions to be maderegarding how the employee buyout can be financed.

Employee buyouts will often be financed through amixture of ‘debt’, ‘equity’ and the business’s ownresources. e mix of any finance package will beunique to each buyout and will depend on manyfactors.

Debt – banks and other financial lenders may beprepared to offer loans to the business to finance anemployee buyout. ese loans will attract acommercial rate of interest and will require regular(monthly/quarterly) repayment for the period of theloan. ese loan repayments must be made in goodtimes and bad and in the event of a loan repaymentdefault these loans must be repaid before anyrepayment of subordinated debt (see over), or returnon equity.


Debt is usually secured against the assets that thebusiness owns such as land and buildings, plant andmachinery, stock, debtors etc, and should the businessdefault on its repayments the lender will be able totake ownership of assets in lieu of the debt.

Once the loan has been repaid in full the lender willcease to have any charge over the assets and the loanrepayments will of course cease.

e benefit to the employees is that this form offinance has a definite end date and, as such, after thisdate the business ceases to make loan payments andcould use this extra money to expand the business,improve terms and conditions etc.

Subordinated debt is debt which ranks afterother debts should a business fall intoliquidation or bankruptcy.

Equity – it is also possible to raise finance as a result of employees taking an equity stake in thecompany by buying ordinary shares from theoutgoing owner(s).

Employees normally decide to make an equityinvestment for two reasons: (1) they believe that the value of their shares will increase over a medium to long period of time; (2) they believe that the business will make sufficient yearly profitsto cover the debt repayment, and any surplus will be shared with the equity holders through thepayment of dividends.

It is important to note that any debt obligations ofthe business will always have to be repaid before anyprofit can be shared among equity holders. As suchthere is no guarantee that equity holders will receiveany return on their investment.

In most employee buyouts, employees areencouraged to help fund the buyout by purchasingordinary shares. ese shares will entitle the holderto part ownership in the business, to aproportionate share of dividends and net assets inthe event of a winding up.

It is worth noting that one of the strengths of anemployee buyout is the opportunity to raise equityfrom a larger number of people than from amanagement buyout, as well as generating a greatercommitment to the future success of the businessbecause employees now have a vested interest in the outcome.

Business’s own resources – some businesses buildup cash reserves over a number of years. is moneycould be contributed to an employee trust to beused to fund the purchase of shares from theoutgoing owner. However, very few businesses buildup sufficient levels of cash to fund 100 per cent ofan employee buyout.

Vendor deferred consideration – in the currenteconomic climate it is difficult for businesses to raisedebt finance unless they can provide asset security.As a result vendor deferred consideration is regularlypart of the funding mix. Essentially the outgoingowner (vendor) receives a proportion of the total dealvalue on completion with the remainder deferredand paid to them over a period of time (typically3–7 years depending on the size of the deal).

e vendor will of course have to be convinced thatthe business will be capable of making the deferredpayments and this can be decided by all parties onlyafter future cash-flows for the business are preparedthat clearly demonstrate the ability to service thesepayments as well as any other debt.

Once the various forms of finance have beenconsidered it should be possible to agree on thepreferred mixture of funding, make contact withlenders and approach employees, assuming they will be asked to invest.

Producing information to support the employeebuyout – it may be necessary to produce a businessplan and financial forecasts to justify how thebuyout can be financed, especially if externalinvestment or equity from employees will be sought.

Stage 4

4.4 Detailed presentation of investigationfindings to investors and bankers andagreement of finance in principle

is is a critical point in the buyout as it requiresexternal finance providers to confirm their intentionto make funds available and also for employees toconfirm any equity investment.

Presentations to finance providers – financeproviders will use this opportunity to gain a greaterinsight into the business and its future management.

Presentation to employees – if employees are beingasked to invest alongside external finance they willneed to understand what it means to become ashareholder, understand the potential benefits andpitfalls and ask questions about the futureownership structure.


Stage 5

4.5 Preparation of legal structure and legaldocuments

e shares of the trading business currently held bythe owner will at some future point be purchased andheld by employees directly, indirectly or through amixture of these. A number of different legalinstruments will be required and these will need to be drafted by a solicitor, perhaps using as a foundation the model documents provided onwww.uk.coop/simplybuyout.

In addition to dealing with the transfer of shareownership from the owner to the employees, the legaldocuments will also enshrine the specific governancestructures that will operate after the buyout.

Creation of an employee trust – an employee trustwill be required if there is to be any form of indirectemployee ownership. e employee trust will beestablished with the purpose of holding shares thatare acquired from the outgoing owner.

Creation of an approved share incentive plan – anall employee share incentive plan might be requiredif the future intent is to encourage directshareholding by employees in the company.

Incorporation of a corporate trustee – both anemployee trust and share incentive plan requiretrustees to manage the affairs of these trusts. Whileit is possible to appoint individual trustees, there area number of benefits of using a corporate trusteeinstead. e corporate trustee is essentially acompany (either limited by shares or limited byguarantee) that is created with the sole intention ofacting as a trustee and has directors, normallyappointed by the board of the trading business andelected by employees of the trading business, whothen appoint an independent director.

Share purchase agreement – this details what isbeing sold, by whom, to whom, for whatconsideration, the date of the completion andrecords all of the warranties offered by the seller.

Articles of Association for the trading company –while these might not need to be completelyreplaced, it is important that sufficient changes aremade to enshrine aspects such as governance,eligibility of members, decisions that requireshareholder approval and the process to be followedshould someone wish to sell their shares.

Loan agreements and other associated documents– assuming there is a requirement for externalfinance the conditions attaching to any debt financeand the ranking of creditors will be negotiated.

Stage 6

4.6 Written offer, subject to contract, madeto the current owner(s). Informationawareness raising and ballots for electedemployees. Keeping management informed.

By this point the hard work should be out of the way.e finance package will have been agreed, theownership model will have been largely agreed andunless there are any last minute hiccups the dealshould complete without any major difficulties,assuming the previously agreed details still stand.

Information awareness – a key element in thesuccess of any employee buyout is ensuring thatemployees understand why the transaction will beof benefit to them and what changes, if any, willhappen as a result. e buyout team will be wellplaced to keep everyone informed.

Ballot processes – assuming that there are positionscreated for employee elected directors and trusteesthere will be a need to explain the purpose of theseroles fully and manage an election process toidentify elected individuals.

Keeping management informed – this is a keyaspect of the employee buyout process that is oftenignored. Managers need to understand the impactthat an employee buyout will have on their role.While managers will still manage post the buyout,the reality is that there is a change of dynamic.Employees are no longer a resource for hire who canbe replaced if the owner tires of them; they areowners and will expect that managers will respectthat they are fellow owners.

Stage 7

4.7 Conclusion of negotiations on terms ofsale. Finalisation of finance arrangements.Transfer of shares.

At this point the transfer of ownership will completeand the employees will own their business. While thisstage is the end of the employee buyout, it shouldsignal the start of building a successful employeeowned business with an ownership culture.


A website to accompany this guide has been createdand contains links to other resources, some short filmsand a model set of documents that could be used asthe foundation for creating an employee ownedbusiness with co-operative principles.

It is important that you seek professional expert advicebefore undertaking a move to employee ownershipand a number of organisations can help guide youthrough the process and ensure that you are able todesign a structure that works for your individualbusiness. Details of these organisations can be foundat the website.

www.uk.coop/simplybuyout

Further information and guidance

Co-operatives UK publications

Simply Legal, 2010

Simply Governance, 2011

Simply Finance, 2011

Simply Startup, 2012

www.uk.coop/simplyseries

e worker co-operative code of governance

www.uk.coop/workercode

Co-operative Development Scotland publications

www.cdscotland.co.uk

Wales Co-operative Centre

www.walescooperative.org/employeeownershipreport

www.walescooperative.org/resources

Co-ownership Solutions

Various guides and case studies on successfulemployee buyouts.

www.coownershipsolutions.co.uk/case-studies

Other employee ownership publications

e Employee Ownership Association has published anumber of guides that provide compelling reasonswhy employee ownership should be chosen. eseguides can be accessed at the EOA website.

www.employeeownership.co.uk/publications/

Hopefully, after reading this guide you will see employeeownership as providing a sensible and realistic businesssuccession solution and will consider converting to an employeeowned structure enshrined with co-operative principles.

5. Next steps


Co-operative Development Scotland

Co-operative Development Scotland (CDS) is aScottish Enterprise subsidiary that promotes co-operative and employee owned enterprise. It has aScottish-wide remit and helps deliver the ScottishGovernment’s strategy for sustainable economicgrowth. Recently supported employee buyouts includeClansman Dynamics, Scott & Fyfe, StewartBuchanan Gauges and Hebridean Jewellery. It isanticipated that a healthy pipeline of enquiries willtranslate into a substantial increase in the number ofScottish headquartered employee owned businesses.

CDS offers clients free, early stage, impartial advice.is includes a formal assessment and feasibility study, undertaken by experienced advisors. Inaddition, CDS's Employee Ownership Ambassadors,all directors of employee owned businesses and active advocates of the model, are willing to engagewith clients.

www.cdscotland.co.uk

Co-ownership Solutions LLP

Simply Buyout has been co-written by AndrewHarrison, Norman Watson and David Daws of Co-ownership Solutions LLP as a distillation of theirexperiences and practice of converting conventionallyowned companies to employee owned businesses.

Co-ownership Solutions specialises in supporting andguiding employee owned business. Specifically, ithelps business owners to choose employee ownershipas their business succession solution, helps businessesto develop an ownership culture and providestechnical advice relating to share schemes and legalaspects relating to employee ownership.

www.coownershipsolutions.co.uk

Wales Co-operative Centre

e Wales Co-operative Centre was set up 30 yearsago and ever since has been helping businesses grow,people find work and communities tackle the issuesthat matter to them. Its advisors work co-operativelyacross Wales, providing expert, flexible and reliablesupport to develop sustainable businesses and strong,inclusive communities. e Centre has a strong andlong standing commitment to supporting employeeownership and increasing employee engagementwithin the workplace.

We have supported employee ownership transitionsthroughout Wales and were instrumental indeveloping the deal that led to more than 200 minersbuying and running Tower Colliery in Hirwaun,Aberdare. e Wales Co-operative Centre employs aspecialist employee buyout team that provides adviceto businesses across Wales on succession planning andemployee ownership.

www.walescooperative.org

Preston City Council

Preston City Council’s current administration iscommitted to supporting co-operatives and employeeowned businesses through a number of initiatives.ese including helping people and communities starttheir own co-operative, looking at creatingcommunity wealth through co-operatives providingemployment for those facing multiple deprivation andassisting those who wish to purchase the business inwhich they work.

e Council can provide links to experts, advice andfinance to those who wish to form a co-operative oremployee owned business.

www.preston.gov.uk/businesses/co-operatives

Co-operatives UK works in partnership with organisationsthat help co-operatives to start up and grow their business.To find out more or contact a local support provider visitwww.uk.coop/start

Acknowledgments


i Scottish Enterprise (9 January 2012). ‘140 new jobs as bicycle business to double in size by 2017’, Co-operative DevelopmentScotland www.scottish-enterprise.com/news/2012/01/140-new-jobs-as-bicycle-business-to-double-in-size-by-2017.aspx

ii e UK Co-operative Economy 2013 www.uk.coop/economy2013

iii Professor Ronald McQuaid, Dr Emma Hollywood, Sue Bond, Dr Jesus Canduela, Alec Richard and Gemma Blackledge (2012).Fit for Work? Health and wellbeing of employees in employee owned business, Final Report to Employee Ownership Associationsponsored by John Lewis Partnership.

iv www.uk.coop/sites/storage/public/downloads/savingbusiness_0.pdf

v Matrix Evidence 2010.

vi CASS Business School by Lampel, et al, 2010.

Co-operatives UKHolyoake HouseHanover StreetManchesterM60 0AS

Tel: 0161 214 1750www.uk.coop

© Co-operatives UK 2013

Paper: www.paperback.coop

Design: www.wave.coop

Simply Buyout: A guide to employee buyouts and becoming anemployee owned business is the co-operative sector’scontribution to the recommendations set out in the GraemeNuttall Review of Employee Ownership carried out for theDepartment for Business, Innovation and Skills in 2012.

This guide was written by Co-ownership Solutions LLP and themodel rules that accompany the guide are provided inassociation with Blake Lapthorn LLP Solicitors.

Documents

BUYOUT - Employee Ownership