Different models of ownership
•Company primarily run for the benefit of the workforce as owners. Company is not run for
any single owner or outside shareholders, but for the sake of everyone who works in it.
•Company wholly or majority owned by their employees, including management, either
directly and/or indirectly via trusts.
•Wide range of ownership structures, but essentially:
•Direct ownership – employees become individual shareholders of shares in the
company they work for (normally using tax advantaged schemes such as Share Incentive
Plan (SIP).
•Indirect ownership – shares held collectively on behalf of employees, normally
through an Employee Benefit Trust (EBT).
•A mix of the above – indirect and direct.
•A fundamental element of employee owned companies is that the employees own shares in
the company either directly or indirectly. It’s obviously important to understand how these
shares might be held, and who might look after them.
© Co-ownership Solutions - Supporting and guiding co-owned organisations
Basic buyout
Equity from
employees
Loans
NEWCO
TARGET
© Co-ownership Solutions - Supporting and guiding co-owned organisations
Basic buyout
Equity from
employees
Loans
NEWCO
Equity from
EBT
Loans
TARGET
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The ‘buyout process’ – 8 stages to completion
Stage 1 – Initial meeting with Owner(S)
•Who is the client? – Owner/management/employee/other?
•Explore reasons for sale and options considered - Why an EBO?
•What are we buying – Share or asset purchase?
•Clarify current ownership – Who can legally sell it?
•Owner involved? – MD/NED/Director/Employee?
•Intentions of owner:
•Main proponent of EBO?
•Full market value or discounted price?
•Remained involved post EBO?
•Family involvement in business post EBO?
•Connected / unconnected parties – Anyone left out?
•Fact finding – What do they do? market conditions? ethical issues?
•Valuation assumptions and preferred method of exit – Value based on? exit how?
•Attitude of ‘managers’ to prospect of sale to employees – Will they back it?
•What timescales are anticipated? – Is it realistic?
SUCCESSFUL EBO = WILLING SELLER & WILLING BUYER
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The ‘buyout process’ – 8 stages to completion
Methods of valuation
•Price for company has to be dealt with at an early stage - Might not be fundable!
•Prepare cash flows ASAP to determine level of debt the company can afford.
•Extra cash in post buyout cash flows – Lose some salaries/dividends?
•2 most common approaches to valuation are by reference to assets and earnings:
•Value of Assets, e.g. Land & Buildings will affect price, but can be funded
through a mortgage or secure Bank Loan. Can be kept out of Assets to be sold,
thus lowering the price, but weakening the new Balance Sheet.
•The value on an earnings basis is usually arrived at by applying a multiple to
either pre-tax or post tax historic profits. On the sale of company as a whole the
pre-tax profit multiple is more commonly used.
•Can apply a multiple to estimated maintainable future profits, but not often
done in EBO’s.
•Bottom line on valuation is based on what both parties will accept as a reasonable
price, and what the funders accept as being fundable. The employees will have to
comfortable with it – If not they might not invest.
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The ‘buyout process’ – 8 stages to completion
Stage 2 – Ratify the assignment
•Explore suitable buyout methods and explain differences:
•Direct shareholding?
•Direct shareholding and EBT?
•Identify and agree company valuation method:
•Valuation mechanism?
•Future performance of business?
•Timing of payment - deferred payments?
•Clearance needed? Justify to HMRC?
•Agree suitable method and structure of proposed deal.
•Agree proposal and terms of reference for the work you will undertake:
•Specify the detail of what will be done by you (timetable of events).
•How many days of work is included?
•Are Legal/Accounting fees included by you or met by client?
•Vendor’s professional advice fees to be covered by?
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The ‘buyout process’ – 8 stages to completion
Stage 3 – Involve the employees / management team
•Permission to speak to all staff? – At what stage? How much information?
•Client? – Has this changed?
•The buyers? – All employees? Management?
•Explain process of buyout – What happens next, proposed terms of deal?
•Co-operative? – Do they understand what a Co-op is? Is it what they want?
•All involved and making investment (51%)? – Willingness to invest? ICOF.
•Same Amounts? – Affordability, commitment of management?
•Need a Buyout Team? – How selected? Size of team? Skills of individuals?
•Unions? – Attitude to proposed ebo?
•Attitude to the sale in terms of taking on or avoiding risk? – Belief in the company?
•Changing roles? – Owners but also Trustees and Directors.
•Methods of internal communication – Through ebo and post ebo
•Staff turnover - Any employees likely to leave/not needed by EBO
•Any Associates / self-employed staff? – Future involvement?
•Current remuneration. Change likely? – Changes affecting cashflows?
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The ‘buyout process’ – 8 stages to completion
Head of Terms agreement
•Important to set terms of the deal early on to test willingness of buyer/seller.
•Can have strong moral force in subsequent negotiations.
•An indicative set of terms setting out the broad terms of the deal.
•Not usually legally binding as often issued before due diligence.
•Some terms are often legally binding:
•Confidentiality;
•Exclusivity;
•Payments of costs (legal/accountancy).
•Includes:
•What is to bought and sold;
•Payment methods and timings;
•Deferred terms.
•Earn out arrangements:
•Retention of assets;
•Management Issues;
•Likely Price to be paid;
•Conditions, warranties and indemnities.
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The ‘buyout process’ – 8 stages to completion
Head of Terms agreement
Typical Heads of Terms letter will include:
•Statement that the offer is subject to contract;
•What is being bought - entire share capital held by whom?;
•Assets included in sale, including intangible assets such as trade names,
leases to be assigned etc;
•A note of any excluded assets;
•A caveat to the effect that the price will be reviewed if any significant changes
occur in the business;
•Proposed terms and method of payment (deferred);
•A statement that the offer is subject to the usual warranties and indemnities to
be given by the sellers;
•Any special conditions the offer is subject to:
•further financial investigation;
•Who is being retained after buyout and agreement on redundancy costs.
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The ‘buyout process’ – 8 stages to completion
Stage 4 – Build the foundations of the future business
•Initial Feasibility:
•Vendors should allow limited initial investigation of the business to ensure that
written outline offers are meaningful.
•This investigation to be carried out by person appointed by the acquirers.
•Due Diligence should not be commenced until Heads of Agreement have been
signed.
•Commercial and Environmental due diligence will also be required, especially
in larger buyouts (Tower Colliery).
•What information are we gathering?
•History of the Company:
•Date of formation and important events.
•Share Capital:
•Authorised and Issued;
•Present Ownership;
•Significant past changes of shareholdings;
•Relationship between shareholders;
•Existing Shareholders agreements.
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The ‘buyout process’ – 8 stages to completion
•Business:
•Sales history;
•Key customers, suppliers and contracts;
•Pricing of products and services;
•Sales predicted & forward orders-profitability? (Primepac)
•R & D Project;
•Accounting Policies;
•Bad debt history and current provisions;
•Stock and work in progress;
•Analysis of sales by distribution channels (Internet);
•Vendor’s assessment of competitors and market.
•Land & Buildings:
•Location;
•Freehold and Leasehold details;
•Amount of floor space;
•Condition of property;
•Most recent valuation of freeholds; (Sutcliffe Play)
•Terms of any space let;
•Surplus space;
•Planning status; (Tower7 Nat Welsh Buses-TESCO)
•Planned improvements/alternative use;
•Insurance cover;
•Estimated cost of refurbishments required by acquirer.
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The ‘buyout process’ – 8 stages to completion
•Plant & Equipment:
•Plant capacity and efficiency;
•Balance sheet value by category;
•Age and condition of major item;
•Capital expenditure contracted, authorised and budgeted.
•Mortgages, Loans and Overdraft:
•Facilities available and use;
•Conditions and terms;
•Interest rates.
•People:
•Employee numbers and wages by dept.;
•Key staff;
•Salaries and Structure;
•Service Contracts;
•Pension fund;
•Share option schemes;
•Health and Safety matters;
•Culture and Style- would it work in employee ownership?
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The ‘buyout process’ – 8 stages to completion
•Contingent Liabilities and issues:
•Major litigation;
•Excessive warranty claims;
•Claims from environmental damage;
•Tax investigations impending.
•Directors:
•Shareholdings in other companies;
•Other directorships;
•Pensions payable to former directors;
•Relatives employed;
•Use of company car;
•Other benefits.
•Begin financial review of current Business.
•Prepare initial P&L and Cashflow forecasts.
•Begin Cultural and Governance Review.
•Begin Business Plan for company post buyout.
•Make initial approach to potential funders.
•Make presentations to staff on implications and methods of investment open to them.
•Design initial share ownership structure.
© Co-ownership Solutions - Supporting and guiding co-owned organisations
The ‘buyout process’ – 8 stages to completion
Stage 5 – Legal review and instructions
•Review of existing Articles and agree changes needed to accommodate form of employee
ownership required:
•Special Consents – 75% shareholder approval for:
•Sale of Company or any Subsidiary;
•Sales of any Shares;
•Application for Listing;
•Any Joint Venture;
•Borrowing limit;
•Resolution to Wind up Company;
•Any changes to Trust Deed including termination;
•Issue of any Further Shares.
•Shareholding Limit - 5% maximum per employee.
•One-person one vote irrespective of shareholding – ICOF stipulation.
•EBT - Permanently holds at least 51%?
•Permitted transfers:
•Sell shares back to company on leaving (Transfer Event)?
•Employees who bought shares at the time of the buyout can have 3 dealing days
before being forced to sell their shares?
•Shares in a transfer event always given priority.
•First offered to EBT/SIP, then to members, then to employees who are not yet
members, then company.
•Lose voting rights?
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The ‘buyout process’ – 8 stages to completion
•Valuation of Shares – NAV/PBIT multiple or could be settled by Auditor.
•Qualifying employees - i.e employees who can buy shares or receive shares through a
SIP scheme. at least 12 months?(18 months max).
•AGM:
•Must be held within 6 months of end of financial year.
•Proxy voting allowed? - yes/no.
•General meetings Quorum - 5th of member’s or 10/20 employees or by Trustees of
EBT or SIP?
•Trustees of SIP - 1 vote for each employee?
•Trustees of EBT - always have majority?
•Should the EBT always be deemed to have the same number of votes as all the
other shareholders in aggregate plus 1?
•Employees may attend General Meetings but will have no vote if they do not hold
any shares.
•Board:
•Employee Directors?:
•Must be a shareholder or awarded shares through SIP?
•How elected?
•Two year term?
•Can be re-elected once but must then wait two years before standing for
election again.
• Quorum – 3 directors present at least 1 must be employee director (if applicable)
and 1 who is not. If not quorate- must meet within a week and then will be quorate.
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The ‘buyout process’ – 8 stages to completion
•Period of notice for meetings - 48 hours?
•Retirement of Directors:
•1/3 of appointed Directors must retire each year at the AGM.
•They can be re-elected at the meeting. If not re-elected they cease to be directors
of the company.
•The directors who have been in office longest shall retire first. Can include a
Director who wishes to retire and not offer themselves for re-election.
• Directors disqualified if they fail to attend 3 consecutive Board meetings.
•Consult BOD and Design the Terms and Conditions of the Employee Benefit Trust and Share
Incentive Plan.
•Prepare Draft Sale and Purchase Agreement:
•Sets out in detail the sellers and the buyers responsibilities to each other.
•May be very detailed, but not always.
•Once signed obliges both parties to complete sale and purchase on the agreed terms.
•The Buyer often insists on completion accounts - a set of accounts agreed after
completion showing the balance sheet at completion.
•If there is a net asset shortfall the seller may need to return some consideration. If there
are any excess net assets additional consideration may be payable.
•This is a useful protection against unexpected balance sheet movements.
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The ‘buyout process’ – 8 stages to completion
•Warranties - statement of fact; can sue for loss if they are false.
•Indemnities - provide that if a certain event takes place a certain payment will be made.
•Usually there is a tax indemnity/covenant for any pre-completion tax liabilities.
•If seller does give warranties they will usually insist on certain limitations to their liability
by:
•time
•value
•Disclosure.
•Disclosure Letter.
•The Buyer cannot sue the seller for any breach of warranty if the breach was validly
disclosed prior to completion.
•The disclosure letter sets out the various matters that contradict the warranties.
•Can be useful source of information about the target company.
•The buyer wants the disclosures to be as clear and certain as possible and will usually
reject any vague disclosures.
•Last minute disclosures usually rejected on the basis that there is not sufficient time to
review them.
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The ‘buyout process’ – 8 stages to completion
Stage 6 – Raising the finance
•Finalise Business Plan (including P&L’s, Cashflows).
•Finalise Funding arrangements, including method of staff investment.
•Prepare Share Prospectus for Staff (if they are investing).
•Prepare instructions for Lawyer to represent Buyout Team.
•Offer Letter to owner.
Stage 7 – Finalise the legal documents and confirm governance positions
•Finalise new Articles and Trust Deeds to include Dealing Day Rules and method of
future share valuation.
•Begin Employee Director/Trustee Training.
•Agree Independent Trustee Position.
•Agree Management Team and methods of internal Governance and
Communication.
•Agree Key Performance Indicators and methods of internal feedback on them for
new Company.
Stage 8 – Celebrate the creation of a co-owned company!
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Purpose and structure of Employee Benefit Trusts
EBTs
•EBT’s normally created so that a company’s shares can be held on behalf of the
employees - often established when a business owner wants to exit the business and sell
to the employees.
•Employees are a beneficiary of the trust – no individual employee owns the shares held
in the EBT.
•EBT’s are normally established with at least 50.1% of the shares so that they are always
the majority shareholder and will always hold a majority of shares on behalf of
employees. This should mean that the business can be run for the long term benefit of
the beneficiaries and not just for short term gain.
•The EBT is the share ‘tank’ holding shares for the long term normally with an intention
never to drop below a certain % of shareholding which would normally be at least 50.1%
ie a majority.
•This ensures that the business is always in control of its own destiny and isn’t subject to
outside influence with different objectives and demands.
•A basic EBT has a set of Trustees and a set of Beneficiaries and a Trust deed that
specifies what the purpose of the Trust is and how the Trustees should administer the
Trust.
•Trustees are likely to be a mixture of board appointments and employees elected by the
employees.
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EBTs continued
•The basic idea is that those who contribute to the success of the company, currently
or in the future, should benefit from the company’s success, and this system is
protected and sustained by the trustees. Therefore the role of an appointed and/or
elected Trustee is an important one.
•The EBT has no requirement for cash as it doesn’t have any financial commitments
and therefore if the company is profitable and declares a dividend the EBT is sitting
on cash. This cash can be distributed to beneficiaries as a bonus.
•EBT can help create an internal share market – assuming that individuals also have
direct share ownership. The EBT could buy back shares from employees, or sell
shares if felt necessary.
•EBT’s are discretionary Trusts which mean that trustees are able to make decisions
at their discretion so long as they observe the terms of the Trust Deed. This means
that they don’t necessarily need to follow the wants of their beneficiaries. ie
beneficiaries might want to sell company and divide the proceeds, or sack the
Directors - Trustees wouldn’t be forced to do this; their decisions would be guided by
what was in the long term interests of the beneficiaries.
•ROLE OF EBT IS NOT TO MANAGE THE DAY TO DAY OPERATION OF THE
BUSINESS.
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Directors
Trustee Company Ltd
Employee
Benefit Trust
Share Incentive
Plan
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EBTs continued
Permanent EBT owned
•Number of Companies structured so that Company must forever be EBT owned:
•Wish of Settlor – John Lewis Partnership, Baxi Partnership;
•Condition of sale/funding – Discounted sale, early BPL investments;
•Belief of employees at time of EBO.
•Trust Deed and/or Articles specify that EBT should always hold a majority. On Sale Event
assets held by EBT gifted to RNLI/Cats home/BPL Charity etc.
•Non-embarrassment clause might be appropriate if business sold at discounted price.
Relationship with Board of Trading Company
•The EBT as the major shareholder of the company should be kept informed regularly on
the financial progress of the company.
•Whilst the Board and Management should be left to manage the company, major
decisions, which affect shareholders, should be referred back to the EBT Trustees/Trust
Company (as shareholder) have duty to hold BOD of Trading Company to account.
•Trustees/Trust Company not responsible for day-to-day operation of Trading Company.
•Often difficult for elected/appointed Trustees to differentiate between paid daily role and
role as Trustee.
•Important to agree and record what decisions might/will be referred to the Trustees.
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Share Incentive Plan
Share Incentive Plan
•SIP is basically a HMRC scheme devised to encourage employees to buy shares in the
company they work for.
•SIP is an ‘all employee’ schemes and is unlike EMI or EBT awards that can be granted to
specific employees.
•All employees must be offered the chance to participate subject to a qualifying period of up to
18 months.
•SIPs are governed by schedule 2 of the Income Tax (earnings and pensions) Act 2003.
•SIP must be formally approved by HMRC in order to benefit from tax and NIC advantages.
•The SIP comprises a trust deed and rules. The SIP is administered by Trustees who acquire
shares in company that has established the scheme. The Trust Deed and rules used for the
SIP are essentially derived from a HMRC instrument and only about 7/8 things can be
changed.
•Shares held in a SIP are either allocated to individuals or unallocated and available for future
awards to employees. All of the shares, allocated or unallocated, are held by Trustees until
they are removed from the SIP.
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Share Incentive Plan
Why would a company operate a SIP?
•Simple, tax efficient way of encouraging direct share ownership.
•Employees can invest, pre-tax and NIC salary, in company they work for and share in future
success of the company through (hopefully) and increase in share value and dividends.
•Success of the ‘investment’ is based on company performance, so employees have a vested
interest in making their company a success.
•Wealth of academic research has consistently concluded that satisfied and incentivised
employees are more productive than those who are unsatisfied and lack comparable forms of
financial incentives.
•There is also a belief that employee retention should improve as SIP participants are subject
to tax deductions on / or forfeiture of their investment if they leave within 3 years of an award
or purchase of shares.
•SIPs allow for the purchase of shares ‘on the drip’ through regular deductions from salary; an
advantage when compared to being required to provide a lump sum for share purchase.
•Trading Company can benefit from Corporation Tax relief for establishing and operating the
plan, and is not liable for employers’ NIC on shares given to, or purchased by, employees
through the plan.
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