Expert briefing session: Employee buyouts

Expert Briefing SessionEmployee Buyouts - Ewan Hall, Baxendale4 February 2014

Employee Buyouts

Objective

• Understand the key decisions and elements involved in a transition to employee ownership

• No two are alike, but there are common themes

Ask questions at any time!

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Agenda / What’s Happening

• Baxendale

• Why an Employee Ownership Transition?

• Differences from a “conventional” exit

• Structuring the Deal: Price / Funding / Protections / Taxation / Leadership / Engagement

• Structuring the Post-Transition: Ownership / Governance / Engagement and Communication

• The Future

• Final Thoughts

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Baxendale

• Employee ownership specialists

• Advise on alternative ownership models

• 13 year track record of offering advice, funding and support

• Worked with more than 80 private and public sector organisations – often with their existing advisers

• Sold domestic boiler company to employees in 1983

• Believe that employees should share in wealth they have created, have a real voice in company

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Sample Structure of a Transition

• The parties:

Company: the organisation that is to transfer into employee ownership.

Owner(s): who own the company at the outset.

Employees: who may acquire some or all of the shares.

Employee Benefit Trust: which may acquire some or all of the shares

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Sample Structure of a Transition

• The parties cont.:

Share Incentive Plan: where employees are to acquire shares directly, this is often done through a SIP.

Bank / Funder: funds the transition, usually secured on the assets of the company (may be the owner).

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Parties

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Funding

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Payment to Owner and Share Transfer

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Why an Employee Ownership Transition?

1. Employee Driven Transition2. Owner Driven Transition3. Hybrid (e.g. owner’s vision, but process driven by

employees)

• Reasons may influence structure• Role of Advisers• Role of Co-operative Development Scotland• Role of Sector

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Why Employee Ownership?

• The Owners:

Control exit Succession Legacy Realise price / value of business

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Why Employee Ownership?

• The Company:

Continuing independence Values of business are maintained Business can stay in current location Productivity and innovation Ability to recruit talent

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Why Employee Ownership?

• The Employees:

Ability to share in rewards Financial stake in business Control of destiny Future succession clear

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Why Employee Ownership?

• Society:

Faster job creation Sustain jobs in local community Greater income equality Health benefits

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Differences from ‘conventional’ exit

• Conventional Exits:

Trade Sale Management Buyout Family Succession Listing

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Differences from ‘conventional’ exit

• Control: No third parties (apart from maybe funders) affecting the decisions and timetable.

• Legacy: An objective is often to secure the legacy of the business / owner.

• Due diligence: Should be limited.

• Post-transfer structure: usually more important.

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Differences from ‘conventional’ exit

• Fairness: Objective may be for all to benefit rather than an individual or small group of individuals.

• Timing: Can take longer than a conventional exit.

• Owner involvement post-transfer: Owners often involved post-transfer, even if only in a non-executive capacity.

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Structuring the Deal

• Price• Funding• Protections for Sellers • Protections for new owners• Taxation• Leadership• Engagement and Communication

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Price

• Usually commercial valuation• But not always arm’s length negotiation• Expectations of Sellers – becoming more realistic?• HMRC?• May need to revisited over the course of the process No agreement on price – no deal

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Funding

1. Lender: Third party funder (bank, specialist lender) provides funds, usually secured on the assets of the company.

2. Employees: Perhaps through SIP. Could be given incentives to invest early (e.g. bonus shares).

3. Seller: Deferred consideration / staggered exit. If used, need to consider protections for Seller.

4. The Company: Company cash. Will also fund the repayment of any Lender or Seller finance.

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Funding

• Can have an impact on timing• When you involve third parties you lose an element of

control over timetable No agreement on price – no deal

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Protections for Seller

• Reasons for protections:

− Deferred Consideration

− Discounted Price

− Protection of Legacy (e.g. preserving skills in a particular area; the name above the door)

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Protections for Seller

• Possible protections:− Veto rights− Right to be a director / trustee− Non-embarrassment provisions− Security− Pre-emption rights− Right to re-purchase shares / convert debt

• Must be balanced against allowing freedom for the business and new owners

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Protections for New Owners

• May require warranties – especially if paying a full price.

• May depend on the extent to which the employees are familiar with all aspects of the business.

• Flexible repayments?

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Taxation

• Capital Gains Tax

• Income Tax

• Inheritance Tax

• See Masterclass later in the year

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Leadership

• Not everyone will buy into / understand the transition from the beginning

• Successful transitions almost always require individuals who will take the lead in the process. This could include:

The current owner

Elected representatives

New management team

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Leadership

• Will also be important going forwards to maximise the benefits of employee ownership.

• Note that leadership does not always mean someone who is in charge – the individual needs to understand the objectives and will commit time and energy to the transition.

• Can sometimes be closer to a cheerleader role.

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Engagement and Communication

• Pre-transition - will vary with the circumstances

• Vital post-transition to maximise advantages of employee ownership

• Pre-transition, will often depend on the expected involvement of the employees (e.g. are they part funding the transition?)

• Elected / nominated working group is common

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Engagement and Communication

• Employees will usually realise something is happening

• They may have been thinking about succession at the same time as owners (or even before)

• Beware inadvertently making misleading statements – especially regarding timetables

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Structuring the Post-Transition

• Ownership

• Governance

• Engagement and Communication

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Models of Employee Ownership

• Direct Employee Ownership

• Indirect Employee Ownership

• Combined Direct and Indirect Employee Ownership

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Direct Share Ownership

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Direct Share Ownership

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Direct Share Ownership

• All the shares in the organisation are held directly by the employees

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Advantages

• Direct Ownership: employees actually own the organisation

• Economic Benefits: all the economic benefits of share ownership go to the employees

• Simplicity: usually a simple concept to grasp

• Control: the employees control the organisation

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Disadvantages

• Checks and balances: no third party to look to the long term and future employees

• Sustainability: how does ownership transfer?

• Administration: share transfers etc.

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Implementation

• How to put shares in the hands of employees?

Employees pay full value for the shares

Employees pay discounted value for the shares (tax implications)

Use HMRC approved share scheme, e.g. Share Incentive Plan

Share Options

Issue partly paid or unpaid shares (tax implications)

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Implementation

• What, if any, criteria should be applied when determining if and when an employee can acquire shares?

• What rights should attach to shares and to shareholders?

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Indirect Share Ownership

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Direct Share Ownership

• All the shares are held on behalf of the employees, usually in a trust for the benefit of the employees

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Advantages

• Sustainability and Stability: Ownership is fixed and stable

• Economic Benefits: The trust can provide economic benefits to employees (although not always very tax efficient)

• Simplicity: One shareholder• Long term: Trustees usually have responsibility to look

long term• Forum: Trust can act as forum for employees• Tax: Should Qualify for the new CGT relief

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Disadvantages

• Is it employee ownership?: No employees own any shares

• Economic Benefits: Capital value remains locked in trust – what incentive is there to increase it?

• Connection: Will employees feel remote from ownership?

• Administration: A tax return will need to be filed for the trust each year

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Implementation

• Key issue is establishing the trust and its remit:

Trustees

Powers

Discretion of trustees

Assets on a winding up

Jurisdiction

Letter of Wishes / Recommendation

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Hybrid

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Hybrid

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Hybrid

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Advantages

• Direct ownership: Employees actually own shares.• Economic Benefits: Can accrue to employees. Trust

will sometimes waive right to dividend to maximise the dividend to employees.

• Sustainability: Ownership of a block of shares is fixed and stable. The EBT will sometimes have a fixed minimum shareholding.

• Tax: Should qualify for new CGT relief if EBT holds >50%

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Advantages

• Long Term: The trustees usually have an obligation to look to the long term interests of the employees.

• Forum: The EBT can act as a forum for employees.• Buying and Selling Shares: The EBT can buy and

(maybe) sell shares. Very useful when acquiring an ex-employee’s shares.

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Disadvantages

• Complexity: Especially with a SIP when you will have two trusts.

• Administration: Record internal share market, tax returns for trusts.

• Value of the business: A significant part of the value of the business will be locked in the trust.

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Implementation

• See previous models• Should the EBT have a minimum shareholding?• Should there be a limit on individual employee’s

shareholdings?• If the EBT holds the majority of the shares, should it

also have a majority of the voting rights?

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Governance

• Allocation of powers / decision-making within the organisation.

• Accountability.• Can facilitate Engagement.

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Conventional Model

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Employee Ownership

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The Parties

• Employees• Directors• Shareholders• Employee Benefit Trust / Trustees• Supervisory / Representative Body• Seller?• Founders / Founding Family?

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The Powers

• Default powers exist for:

Shareholders (ultimate controllers of the company)

Directors (day to day control of the company)

• Within some limits, you can amend these default powers to grant greater or lesser powers to these groups – and grant new powers to other groups (e.g. employees)

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The Powers

• There is no definitive list of powers (they will vary), but issues to consider include:

Who appoints directors?

Who appoints trustees?

Are certain decisions so fundamental to an organisation that everyone should be involved (e.g. a sale of the business)?

But avoid management by committee – you need an effective management structure

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The Powers

• Majority / Unanimous / Super majority vote?

• Consent from more than one body?

• Opportunity for consultation / discussion prior to decision?

• Quorum for meetings

• Should there be a permanent block on certain decisions?

• Confidentiality

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Engagement and Communication

• Vital to maximise the benefits of employee ownership• Can have a number of roles:

Awareness

Education

Transparency / Trust

Accountability / Governance

Inclusiveness / Partnership

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Engagement and Communication

• Detail will vary, but some broad principles:

Time: will be needed

Proactive: should not be passive

Structure / Responsibility: formally allocate responsibility to certain bodies / individuals

Two-way: communication should work both ways

Dynamic: usually needs to be able to evolve and change over time

Confidentiality: consider if applicable

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The Future for the Organisation

• The importance of flexibility• Revisit structures and models in the future• But:

consider whether certain elements should be immovable – or subject to special consents

should one generation of employees be able to ‘cash out’ at the expense of earlier and future generations?

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The Future for the Sector

• £70m of tax reliefs from the government in 2014

• Employee Ownership Day

• Evidence showing the benefits growing

• 2012 / 13 – Number of EO businesses increased by over 10%

• Objective of 10% of GDP

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Final Thoughts

• Extremely flexible model

• There can be a degree of complexity involved

• No two will be alike

• Beware the tax tail (or any other tail) wagging the dog

• The importance of leaders / cheerleaders

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Ewan Hallewan.hall@baxendale.co.uk

07880 382 102

http://www.baxendaleownership.co.uk/

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Future Briefing Sessions

• Funding the employee buy-out, 9 April 2014 , Glasgow

• Tax implications in employee ownership, 7 May 2014, Glasgow

• Employee share ownership, 10 September 2014, Edinburgh

• Governance in the employee owned business, 5 November 2014, Glasgow

For more information visit: www.cdscotland.co.uk