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Employee ownership is all fine and dandy until the time comes to sell up, when things can get complicated
There has been much publicity in recent months in relation to the Government’s drive to promote the idea of employee ownership of businesses, particularly following the publication of and reaction to the Nuttall Review last year.
Employee ownership as a concept is somewhat loosely defined, but at its roots boils down to all employees (not just founders or senior management) having a significant and meaningful equity stake in the business. This would usually mean the employees share in the benefits and profits of the enterprise and the organisation is structured so as to promote employee engagement.
The proposals form part of the Government’s wider efforts to encourage enterprise and unlock growth, and its supporters hail the fact that the interests of the employees become inherently aligned, which they argue results in a more focused, driven and responsible workforce.
A number of high-profile enterprises use an employee ownership model, including John Lewis, although evidence suggests employee ownership is most successful as a model in smaller enterprises of around 75 or 100 employees, when ownership can be coupled with effective engagement.
The implementation of employee ownership structures can give rise to a number of corporate, regulatory, employment, tax and pricing issues and, in part, these are being addressed as part of the Government’s work and consultation in this area.
However, one thing that has received very little attention is the question of what happens to an employee-owned enterprise in the event that it continues to prosper and ultimately becomes an acquisition target. How easy would it be for the employee-owners to sell up and realise their investment?
M&A involving a significant number of employee-owners can throw up a raft of complex issues. By way of example, much of the value in the business will likely lie in the employees themselves, who the buyer will need to keep incentivised post-completion. This can give rise to challenges if the employees reap a significant capital gain and could require creativity in relation to the selling employees’ compensation packages and terms.
In these circumstances the buyer may also be reluctant to seek recourse from the employee-sellers in the event that any of the warranties turn out to be untrue or indemnities need to be called upon.
This in turn can lead buyers to consider a mixture of other deal protection mechanisms such as warranty insurance, escrow arrangements and deferred consideration, and can sometimes lead to a preference for asset sales over share sales.
The complexity involved in an exit is an unintended consequence of the employee ownership campaign, which inherently focuses on the benefits the model can bring while the enterprise remains in the hands of the employee-owners.
Nevertheless, exits from employee-owned businesses can and do happen, and while there may be solutions and structures available to address the issues the feasibility of an exit is something that should be remembered and factored in to considerations from the outset.