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Employee ownership: Pros and cons of selling your company to your staff
At a glance
- A growing number of business directors are making the decision to pass a controlling stake in their company to their employees.
- Employee-owned businesses enjoy various tax advantages and often experience higher productivity and greater economic resilience.
- Employee ownership can be a complex and time-consuming option, however, so it’s important to take expert advice and ensure it fits with your long-term financial goals.
For SME owners, employee ownership can be a challenging exit option. But an increasing number are finding it worthwhile, as it has substantial attractions for the owner, the staff and the business – including some tax advantages.
Employee-owned businesses in the UK more than doubled to 1,300 in the three years to December 2022, according to the Employee Ownership Association (EOA)1. This is due to increased awareness of the options among firms and advisers; the pandemic forcing owners to plan succession; and businesses aiming to improve people impacts as part of sustainability goals.
According to the EOA, employee-owned businesses see greater productivity, are more resilient to economic turbulence and have less stressed and more engaged and fulfilled workers2. Employee ownership unlocks this performance by boosting special effort and common purpose among staff. It enables more sustainable business models that are rooted in local job markets, and a greater ability to plan long term. It also promotes more inclusive, transparent and effective governance and employee engagement models.
Why employee ownership?
Using employee ownership as an exit strategy involves either transferring shares to individual employees directly, or indirectly, by creating an employee ownership trust (EOT) to hold shares on employees’ behalf. Alternatively, it could combine direct and indirect ownership.
Ian Fraser, Head of Employee Incentives at Harper James, says EOTs can provide an effective exit for SME shareholders when a trade buyer is hard to find, or they are concerned buyers won’t protect employees’ interests or the culture.
It also has attractive benefits in the current economic environment. Craig West, CEO of exit-planning adviser Succession Plus, says: “Tight labour markets, the great resignation, working from home and baby boomers exiting the workforce all make retaining and motivating employees critical. Equity ownership is a proven way to incentivise them. Employee ownership also provides a unique combination of ‘harvest’ and ‘legacy’ for exiting owners.
“Multiple clients of mine have become strong advocates of employee ownership for succession, to protect assets and share the wealth among key employees. In an SME, employee ownership usually becomes a great economic multiplier with a disproportionate impact, and employees, founders and the business all better off.”
What are the advantages of employee ownership?
One of the primary advantages of employee ownership is the tax benefits available. For example, direct employee ownership can use tax-advantaged share plans, such as enterprise management incentives or company share-option plans.
EOTs also offer significant tax benefits for employees and selling individuals. Ian says an EOT can be a tax-efficient way to sell shares, as it allows a tax-free sale rather than having to pay Capital Gains Tax rates up to 20%.
Once the trust takes ownership, it can also pay employee bonuses free of Income Tax, up to a limit of £3,600. But you must meet the EOT requirements on trading, all-employee benefits, controlling interests and limited participation to qualify, so it’s a good idea to take professional tax and legal advice.
Conditions include that the employee ownership trust must retain at least 51% of the company. “This means you must relinquish control, but you can protect your interests in future performance and deferred consideration by remaining involved with the business,” says Ian.
Employee ownership corporate structure: nine considerations
1. Decide if the model will include all or most of your employees, or senior staff only. Then make sure all parties, including employees, are keen on the deal before you start.
2. How will employees control the company? This could be an employee council, but it’s often a combination of selling shareholders, senior employees and independent trustees.
3. If using the employee-ownership trust model, who will be the trustees? Simon Martin, Chartered Financial Planner at Technical Connection, says this is a critical decision, as they will be a key part of the future business model.
4. How will employees fund the purchase and acquire shares? For example, it could be through earn-in, buy-in, loan (including from the company or founders), profit share, bonus payments, salary sacrifice or company contributions. Often, companies pay an upfront sum from cash reserves, plus a deferred consideration from future profits.
5. Are you confident your company can continue to succeed and pay a deferred consideration? Ian says this is one reason selling shareholders often want to remain involved after the sale.
6. What incentives will employees receive – such as bonuses, share options or other equity incentives – to encourage future growth?
7. What rules will you use to deliver business outcomes? These can include clauses in which resigning or dismissed employees forfeit share rights, and rules protecting the interests of majority and minority shareholders.
8. How will you manage any potential conflicts of interest? For example, Ian says that if selling shareholders are directors of the corporate trust, they must act in the interests of the trust beneficiaries. This can lead to conflicts about short-term profits versus employees’ long-term interests.
Employee ownership challenges and solutions
A challenge is that employee ownership is often not a fast exit strategy. “Most successful plans implement over several years – say, seven to ten,” says Craig. “This is mainly due to employees needing to position to afford a buy-in. Early preparation is critical.”
Employee-ownership exits are more successful – with company, employees and founders all better off – when education on the strategy, how it works and how to affect performance changes are included in the implementation plan, he adds.
“All involved must understand the financial and non-financial value drivers and risks, and how employee shareholders can help accelerate value,” says Craig. “Another typical challenge is that employee involvement in decisions is critical to success, but owners can be reluctant to relinquish control.”
Taking personal advice
Given the copious tax and legal requirements, seeking advice is hugely important.
Simon says that a successful outcome for owners also relies on planning your personal finances. For example, selling to employees often involves a deferred payment. So you need to ensure this fits with your personal goals.
We work in conjunction with an extensive network of external SME specialists, and together, we can help you achieve a holistic view of all your exit options and what you want to achieve. We can help you develop a financial plan around the sale, including taxation, investment strategies and income needs.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
Exit strategies may include the referral to a service that is separate and distinct to those offered by St. James’s Place.
Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.
Sources
1, 2Employee Ownership Association, ‘What the evidence tells us’, accessed May 2023
SJP Approved 31/05/2023
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