From IN THE BLACK April 06
When it comes to succession planning, many business owners overlook the obvious: selling to their own employees.
It’s the dilemma facing all ageing business owners. What to do with the company upon retirement? Many will choose a trade sale of the business. But few are thinking about a sale to their employees.
The average age of a family business owner is 57. Over the next five years, more than 40 per cent of business owners are set to retire, many hoping the business will fund it, according to research from CPA Australia.
In rural Australia, many family businesses are sold to competitors who have one aim: to close the business down. This means the loss of jobs and, in rural areas, vital local services such as shops or petrol stations.
Alan Greig, of consultancy The Mercury Centre, says that many owners fail to think about selling their business to its employees. ‘What we are finding is that the market is just so uninformed about the additional option of looking to the employees, or even management groups, to buy the business,’ he says. ‘Employers are hanging on too long. They see the need to preserve jobs but they may be conservative about discussing it with employee groups. Often they [employees] find out they are [sold] after they’ve gone to a trade sale.’
Greig says there is ignorance over alternative options. He says that many financial advisers have never considered that employees could buy a business. When employees are informed the business for which they work is for sale, Greig says their reaction is often: ‘Gee, that’s a fascinating initiative. How can that be done? Are they interested? Is it allowed?’
Peak Partners’ Craig West CPA specialises in succession planning. He developed a package that can help ageing business owners to exit their companies and involve their staff in a cost-effective way, all of which is described in the booklet Planning Your Get Away.
‘The biggest problem in rural areas is the market for sale is so much more reduced,’ he says. ‘In country towns the market is pretty limited. That just cuts out that option even more for them. It is a big issue in smaller communities or regional areas.’
Greig says that businesses with ageing owners can become un-stable. Employees worry about their jobs and move on while the owner tends to keep plans secret. Often it is only after a sale has been announced that they discover that the employees would be interested in buying the business.
This problem isn’t confined to Australia. In the European Union it is estimated that 30,000 companies close each year, costing 300,000 jobs through bungled succession planning.
A survey of the UK in 2001 found that nearly one-third of business closures were caused by failures in succession planning.
Greig argues that the employees can be the best sale option. They know and understand the business and, not being a distress sale, it means the owner can get a better price. ‘What we are saying is that if you work with your employees in a structured or staged process you are likely to get a much better price for your business than you will through a trade sale.’
But the market for employee buyouts is small in Australia, especially when compared to the US, EU and the UK. There are few tax or other financial concessions driving the market and little support for the idea from financial institutions.
In the UK last year the Chancellor of The Exchequer, Gordon Brown, threw his weight behind employee share ownership. ‘Employee ownership is world changing,’ he said. ‘It is the way ahead for the UK in the global economy. It reflects that human capital is becoming more important than physical assets. A company is more and more defined by its skills. It relies more on its creative energies … The global economy will succeed when employees feel they have a stake in the business.’
Says Greig: ‘There is a huge discrepancy in Europe and North America compared to what’s occurring in Australia.’
West says the practice of employees buying the business that employs them is more common overseas. But he adds that awareness about the possibility of employee buyouts in increasing. Awareness of the existence of a framework to make the practice possible, in terms of compliance and legislation, is also on the rise.
Many ASX-listed companies have employee share plans but legislation makes it expensive for private companies to introduce them. ‘The problem is employee share plans that are set up for public companies encourage employee ownership and employee participation but they simply don’t work in small businesses,’ West says.
‘You give an employee a share in a small business and they’ve got a share they really can’t value. It’s probably [not] liquid and the only person who might buy it back is the owner. It’s got very little value in getting them engaged or enrolled in small business ownership.’
Greig is developing a scheme that can cheaply involve employees in a company by converting a Pty to a cooperative. Each member of the cooperative has a single voting share. The value of the original shareholding is capitalised into a form of ‘B’ shares known as Cooperate Capital Units.
Although he has yet to secure his first deal using this method, he says it will overcome the cost of producing a prospectus for a public company, which must be used if there are more than 50 shareholders.
‘If you’ve 400 shareholders you’d have [to] use a public company and it would cost you 100 grand to set up,’ Greig says. ‘Doing a cooperative would cost you 20 grand. Unfortunately, most advisers in country areas would advise you to take that path. What we are trying to say is that the coop option is better and cheaper.’
West sees similar problems. ‘One of the big problems people have got is [when] they go to their normal accountant and ask for an employee share incentive plan,’ he says. ‘They can all do it, there’s no rocket science in it, really. But most accountants would say that it’s going to cost you $60,000 to $100,000. We’re doing them for $15,000 all up.’
What West does is sidestep the public company prospectus requirements by establishing a trust, which can also overcome the problem of funding an employee buy in.
‘The big gap they’ve got is that by the time somebody gets to the age where they are likely to be offered a partnership, they’ve probably just got married, just bought a house, just had a kid, which is not the ideal time for them to go and borrow a quarter of a million bucks to buy into an accounting firm,’ West says.
West has developed some ingenious funding mechanisms, usually linked to incentive plans. Based on profit increases, performance payments are made to a trust that builds an employee’s stake in a business.
One example is a demolition business where staff were losing and damaging expensive equipment. West developed a trust, which is used to buy all the tools and equipment in the business. ‘Therefore all the employees directly own all the tools and equipment, and he [the owner] doesn’t lose any more.’
‘If you use it to buy shares in the business from the succession point of view you can gradually bring employees in as owners of the business. But they are not direct shareholders, which is a big advantage.’ The company shareholder register doesn’t fragment into many shareholders with small holdings.
Says West: ‘Really, you are only introducing one shareholder, which is a trust.’