Why transition to employee ownership over a simple sale of the business?
Employee ownership can be a preferred option available to businesses when considering succession planning. In this article we consider why.
As we covered in our article 'What structures are available for employee ownership?' there are three main structures for moving to employee ownership, but why would you want to consider this in place of simple share sale to a third-party purchaser? We make the assumption that passing on the business to other family members is not considered workable.
When selling your business to a third party this will often be to a competitor or a corporate investor, each of which are looking to further their own aims and may not necessarily have the best interests of your business at heart. Anecdotal evidence from business owners has shown that the process of selling to a third party can often be fraught, and sometimes unpleasant. The end result may be achieving a reasonable value for the business but the long term future of the business in its current location may be in doubt, and certainly the culture and ethos is liable to be damaged or change significantly.
If the primary driver behind the decision to sell is one of realising the value of the business as soon as possible, then a sale to a third-party may be the quickest, and most financially viable, route.
If, however, realisation of the value can be done over a wider time period, and the owners are concerned about the continued success of the business and maintaining its culture and people, then an employee ownership transition could be more attractive.
A transition to an employee-owned structure is also ideal for putting in place long-term succession planning where you have employees, or family members if it is a family business, who you want to be able to run the company going forward.
If considering a direct ownership structure then, of course, the employees would need to be able to afford the cost of the shares if these were to be bought, and not gifted. This will often not be viable and so this is why the trust owned structure is more appealing. Sale to an employee ownership trust can also, if certain statutory condition are met, mean that no capital gains tax is due on the sale of the shares, which can mean a substantial saving for the outgoing owner (in particular if the company was set up by the outgoing owner so that the gain is the entire value of the business).
The CGT relief can be used to justify a slight reduction in the sale price (the shares may be sold for slightly less than on the open market, but with no CGT payable the eventual financial gain for the outgoing owner is greater).
When setting up a trust structure the trust itself will have no assets so the company will need to gift money to it in order for it to then pay the sale price for the shares. This is why there is often an initial, day one, payment to the owners with the balance being deferred and paid out over a number of years. Careful analysis of the financial state of the business, a management team for the succession, combined with a robust payment plan for the deferred consideration, is key to ensuring both the continued success of the business and also the financial gain for the outgoing owner.
It is also not unusual for the outgoing owner to remain in the business for a while after the sale, which allows them to keep an eye on the business whilst also starting to take more of a back seat to enable the succession planning to take effect, whilst still being able to enjoy the benefit of selling the shares and realising the financial reward of having grown the business in the first place.
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The information in this article is necessarily of a general nature. The law stated is correct at the date (stated above) this article was first posted to our website. Specific advice should be sought for specific situations. If you have any queries or need any legal advice please feel free to contact Wrigleys Solicitors.