How to make employee ownership work for your business

The thought of every employee working together, with a shared vision of what business success looks like, is a dream situation for any company. Could switching to an employee-owned business model be a sensible and profitable move? Here's how to do it.

by Gary Davie
Last Updated: 09 Oct 2013

At the start of 2012, the government announced its support for employee ownership in principle - recognising its ability to promote long-term thinking and encourage growth. Since then, a number of legal changes and possible tax incentives have been announced, aimed at helping private companies to make the transition to employee ownership.

They seem to be doing the trick. At last count, the number of employee-owned businesses in the UK is increasing by 10% year on year, according to the Employee Ownership Association. And these enterprises contribute more than £30bn to UK GDP each year.

For private companies that may be thinking of making the transition to employee ownership here is some advice about how to go about it:

Be clear why you want to change

Private businesses may consider adopting an employee-owned business model for a variety of reasons. For a long-established family business, where the business owner is seeking an exit in order to retire, an employee-owned business model could allow him to do this while leaving the business in safe hands, backed by a committed and empowered workforce.

It is a decision that can make good financial sense too. It may not be a traditional exit route and won’t necessarily generate the best returns for the out-going business owner, but it can leave the company on a secure financial footing and help secure its long-term future.

Will you choose direct or indirect share ownership?

Under direct ownership, employees will own the shares directly. Under indirect ownership, an Employee Benefit Trust is set up to hold the shares and employees may get the benefit of profits distributed by the trust.

The former may be preferred because each employee receives their own shares evidenced by a share certificate and this can help to engender a sense of ownership. On the other hand, indirect share ownership may be preferred because it removes the need to buy back shares from employees when they leave the company and all the complications associated with determining exactly what rights the employee shares will carry. It may also allow the retiring shareholders to share responsibility, alongside a professional trustee and employee representatives perhaps, for administering the trust and deciding who should benefit.

Share buybacks will soon be easier

An amendment to the Companies Act 2006, due to take effect later this year, will facilitate share buybacks for private companies that use direct share ownership. The number of shareholders needed to approve buybacks of a company’s own shares is being lowered from 75% to 50%. It is also going to be possible for private limited companies to pay for its own shares in instalments and to hold them in ‘treasury’ so they can be treated as treasury shares.

HMRC scepticism

One of the main barriers to indirect employee share ownership in the past has been a significant level of HMRC scepticism about whether the move is being taken for bona fide business reasons or as a means of tax avoidance. It is hoped that the Government’s support for employee ownership will help to bring about a marked difference in this approach.

Doing it in stages

As bank finance is usually needed to make the transition to employee ownership, it can be drawn in stages to alleviate pressure on cash flow. For example, a proportion of the shares might be purchased initially by the Employee Benefit Trust and/or employees. The remaining shares could then be purchased at a later date. It may also be possible to agree deferred terms with the shareholders so that they transfer complete ownership from day one but the payment for the shares is deferred.

Achieving a fair valuation

Before considering a switch to employee ownership, it is necessary to obtain a fair and accurate valuation of the business and in uncertain economic times this is rarely a straightforward matter. Always seek professional business valuation advice from someone who has good knowledge of the market sector in which the business is operating. In some cases, the outgoing shareholders may be willing to accept a discount on the valuation too.

Role of the board of directors

New employee-owned businesses will usually choose to retain their existing Board of Directors to take responsibility for the day-to-day management of the business and for ensuring its business strategy stays on course. However, the Board will now be answerable and owe their legal responsibilities as directors to a different  shareholder base - the employees, or trustees acting for the benefit of employees.

Gary Davie is corporate partner at Shakespeares and specialises in helping private companies to make the transition to employee ownership.

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