Selling to employees

Where no family successor exists and an external sale is unattractive, transferring ownership to employees is a route that suits certain businesses well.

The forms it takes

An employee stock ownership plan. A qualified retirement plan holding company shares for employees, with the plan purchasing shares from the owner.

Highly structured, subject to retirement plan regulation, and carrying substantial tax advantages.

A direct management buyout, where a small group of senior employees purchase the business personally.

Simpler, and it concentrates ownership rather than distributing it.

A worker cooperative, where employees own and govern the business on a one-member-one-vote basis.

Less common in most sectors and well established in some.

An employee ownership trust, which holds shares on behalf of employees collectively.

Increasingly used, and generally simpler and cheaper to establish than a formal ownership plan.

The tax advantages of the plan structure

Substantial and specific.

An owner selling to a qualifying plan may, in defined circumstances and subject to conditions, defer capital gains tax by reinvesting the proceeds in qualifying securities.

Contributions used to repay acquisition debt are generally deductible, which effectively allows the purchase to be funded with pre-tax dollars.

Where the company is structured as a pass-through entity wholly owned by the plan, the portion of income attributable to the plan's ownership may not be subject to federal income tax.

These provisions are the reason the structure exists and they carry strict qualification requirements.

The costs and complexity

Which are the main obstacle.

Establishing a formal plan involves feasibility study, legal and plan design work, an independent valuation and trustee arrangements — generally a six-figure cost for a business of any size.

Ongoing obligations include annual independent valuation, plan administration, regulatory filings and fiduciary compliance.

The repurchase obligation is the most significant long-term issue: as employees leave or retire, the company must generally buy back their shares, which creates a growing cash requirement that must be planned for.

Businesses that failed to plan for this have encountered serious difficulty.

Which businesses suit it

The characteristics that make it viable.

Sufficient size to absorb the cost — advisers commonly suggest a meaningful number of employees and a certain level of profitability.

Stable and predictable cash flow to service acquisition debt.

A capable management team who will remain.

An owner willing to sell at a fair value determined by independent appraisal rather than negotiating for the highest possible price.

A workforce for whom ownership is meaningful, which is partly cultural.

What it achieves beyond the transaction

The arguments made in its favour.

Continuity: the business remains, the jobs remain, and the location generally remains, which matters to owners with a connection to their community.

Research on employee-owned companies has generally found comparable or better performance on productivity and stability, and lower turnover, though the causal direction is debated and firms that adopt employee ownership may differ systematically.

Employees accumulate retirement assets, which for many is substantially more than they would otherwise have.

And the owner exits at a fair value with favourable tax treatment.

The concentration risk

The honest counterweight.

Employees whose retirement savings and employment both depend on the same company are exposed twice.

Where the business fails, they lose both, and there are well-known examples of this occurring.

Responsible plans encourage diversification and provide other retirement saving alongside, and this consideration is worth taking seriously rather than treating as theoretical.

Getting started

The conventional sequence.

A feasibility study, assessing whether the business can support the structure and what it would cost.

An independent valuation.

Decisions on the form, the financing and the governance.

Implementation, and then a communication programme, since employees who do not understand what they own derive little benefit from it.

That last point is consistently identified as the difference between employee ownership that changes a company and employee ownership that is merely a financing structure.

General information only, not legal, tax or business advice. Employee ownership structures are highly regulated — consult specialist advisers.