Employee ownership can be a great way to pass on a business to the next generation, ensuring local ownership continues and keeping jobs in the community. It is also a viable solution for business owners looking to retire while at the same time ensuring their legacy continues.
Unfortunately, it is often overlooked as a succession strategy.
An employee or management buyout is the acquisition of all or a majority of the business owner’s shares in the company by the employees. The transfer can be done over time or all at once, with the end goal of transferring a controlling interest to the new owners. Contrast this with an employee share ownership program, which is typically structured to allow employees to buy a more limited number of shares.
Employee buyouts can be used for small businesses all the way up to middle-market companies with hundreds of employees. Most commonly, we have helped finance the purchase of companies with 20 to 100 employees, and in just about all of these transactions the companies not only survived, they have gone on to thrive. One of the keys to success is having a great management team. We look for employees who have worked at the company for a number of years, and who together have experience running all the key management functions.
The retiring owner must delegate management responsibilities in a phased approach and be willing to let go. The management team needs to have demonstrated real leadership abilities.
Tetrad Computer Applications, a Vancouver company that provides geographic and demographic market analysis software and data, completed a successful employee buyout in 2012. Tetrad president Michael Simon and three other managers who bought the company have gone on to double the size of the business. Simon’s advice to budding entrepreneurs is to focus on the business basics.
“After closing the MBO [management buyout] you have to transition quickly from the excitement of working on the deal to running the business,” Simon said. “Don’t think about the debt load, just get moving and make the moves that you intuitively know are best for growth. We kept things simple and focused on profitability.”
I watched Tetrad management pay attention to every detail, from when to hire to how to reduce their rent costs.
Simon’s advice is to clearly delineate between one’s ownership and employment role.
“A common mistake is confusing your ownership position in the company with your operational role in the business,” he said. “Avoid this by establishing a clear understanding of the leadership structure and discuss how each owner will participate in future profits.”
Many companies have all the ingredients for success but do not consider employee buyouts because they do not think they can raise the money.
Depending on what the company is worth, there are numerous options available for financing. These include senior debt, mezzanine financing and equity. Good advisers can direct you to the right sources and steer you through the process.
These financing solutions enable management to buy the business even if they do not have a lot of money. Of course, management must put their “skin in the game,” an amount that is meaningful for them and their families to ensure commitment and alignment.
For larger deals in which an equity partner is needed, managers can negotiate long-term incentive programs, often called earn-ups, to allow them to earn additional equity if they hit defined performance benchmarks. After five or six years, if everything goes well, they can buy out the business and achieve 100% ownership.
Simon’s team has now paid off all its financing and owns the business outright. It demonstrates that employee share ownership can align the interests of owners and management and unleash creative energy to grow companies and jobs.
Business owners contemplating retirement should consider the option as a way to ensure their companies continue to thrive in the future. •
Robert Napoli, ([email protected]) is vice-president of First West Capital, a line of business of First West Credit Union that finances acquisitions, buyouts and growth.
