Selling your Business to Employees IoD and ESOP Centre 15 May 2012

Selling to which employees? Selected key employees? All employees?

Shares for all your employees? A potentially powerful tool for improving performance Research evidence* Like any good tool, it needs to be applied with skill and some forward thinking * e.g. Cass Business School

Some companies owned by all their employees Gripple - manufacturing Arup – engineering consulting John Lewis Scott Bader – polymer manufacturing Circle Health – operators of hospitals Skye Instruments – electronic instrumentation

When might you consider selling to your employees? No or very few potential buyers Business relies on “human capital” Strong cash flow You are willing to be paid over several years You believe the business has good growth prospects if owned by those working in it Others?

Key questions What is your business worth? and Where will the money come from?

Where your employees may be able to pay the purchase price Value strongly linked to people working in the business (e.g. professional services, consulting, marketing) Low asset base Few potential purchasers Value based on a low multiple of profit Tax reliefs for employees purchasing shares

Where market value exceeds what your employees can afford Explore bridging the gap with: Payments out of your company’s future profits Bank borrowing Accepting a discounted price Other forms of finance Private equity (but this will normally lead to an onward sale of the company)

Case studies (all real companies)

Selling to your key managers Architects practice Partnership with two partners 25 employees Turnover £2.3m Profit £200,000 after partner drawings Partners wanted to plan for succession

Selling to your key managers Solution: Incorporate the practice Transfer it to a limited company for £1.5m How does the company pay the £1.5m? £1.35m left as loan from company payable over seven years £155,000 paid in shares Three new directors also subscribe for 15,000 shares each in the new company, paying £15,000 each

The result so far New company New directorsFormer partners 22.5% 77.5%

Further transfers of ownership to the new directors New company New directorsFormer partners 45% 55% Grants of EMI options over a further 22.5%* * Allows new directors to acquire a further 22.5% at today’s low value

Completing the transfer of ownership to the new directors New company New directorsFormer partners 100% 0% When they wish to retire, offer remaining shares at a price based solely on retained profits

Summary Of current value (£1.5m), current owners fix £1.35m, to be paid out of cash flow They hold the remainder as equity (77.5%), and are willing to reduce that to 55% for nominal payment from new directors For an aggregate investment of £45,000 (£15,000 each) new directors acquire 22.5% They can increase this to 45% tax efficiently by exercise of EMI options They can increase to 100% when former partners retire, on a favourable valuation basis

What if the business was already a company? Same principles could apply New company buys old company, in return for loan notes/preference shares and equity in new company Key effect: current owners can fix value, so new owners enjoy some or all of growth in value from date of purchase by new company

Selling to all employees Sound recording business Founders wish to sell 100% to “John Lewis” style employee trust - no individual share ownership They are willing to paid out over ten years They would like to retire gradually over that period

A simple possible approach: Establish an employees’ trust The trust agrees to buy out founders, paying £200k per annum over ten years (subject to adjustment according to available funding) Subject to available cash, the Company funds the trust to purchase the shares over that period – not corporation tax deductible Trust retains shares indefinitely

A variation Individual share ownership is felt to be important: Sell to a SIP instead of to an employees’ trust Company can deduct against corp. tax payments to SIP SIP then passes shares to employees over time. They can buy shares with tax relief and/or be given shares free of tax Establish internal market to facilitate future sale and purchase

A second variation The Company is unlikely to have sufficient cash to pay £2m: Reduce the price Bring in external finance Consider allowing employees to acquire some shares directly through a SIP – with tax relief

How the SIP might work Company Seller(s) SIP trust 1. Pays money to trust, pre- corporation tax 2. Pays money to sellers – may be able to defer CGT 3. Sells shares to SIP trust Employees 4. Employees can receive free shares – not taxed 5. Employees can buy Shares – income tax relief