Would an employee buyout always be appropriate?

An employee buyout will not be appropriate in every situation for a variety of reasons. The key to any successful employee buyout is proper planning in the initial stages to ensure that your organisation and situation is compatible with an employee buyout. Part of this planning has to be an assessment of how your current position satisfies the critical success factors for an employee buyout.

There are four major critical success factors:

• a willing seller
• a willing buyer
• a board of directors / management team / individual capable of leading the business when the owner exits
• a financially viable proposition

A willing seller

Clearly, an employee buyout will not succeed if the existing owners of the business are not willing to sell the business, or will only sell the business for what might appear an excessive price.

There are many situations where the owner, or owners, of a business may want to sell the business or a percentage of it:

• Retirement – Where a business is privately owned, the sole or principal shareholder may be nearing retirement and may want to sell their investment in the business. Private owners are normally concerned about whom they sell their business to, as they want to maintain the independence of the business and ensure it doesn’t deteriorate and jeopardise employees’ jobs, also they may not like the prospect of selling to a competitor with whom they’ve competed for a number of years. The sale of the business to employees protects the workforce, maintains its independence, keeps the business in the community and ensures that the name above the door doesn’t need to change.

• Realisation of investment - The current owners of a business may require their funds, or may not want to continue with their investment in the business, or due to personal circumstances might need to realise their value at short notice.

• Exit of a business Partner – Where one of the owners wishes to exit the business and the remaining owner is unable or unwilling to buy the share available, the employees are likely to be seen as a far better option than an unknown outside replacement investor.

• Divestment – There have been a number of instances where a parent company wishes to sell a subsidiary, which is not part of its core business or part of its future plans, in order to obtain funds to reduce borrowings or make an investment elsewhere, or for other strategic reasons. If the subsidiary can continue to be a viable business an employee buyout can ensure that jobs are preserved and the business continues to impact on the local economy.

• Business in distress - A poorly performing business may be threatened with closure by its current owners to prevent further losses. In order to save their jobs, the employees could buy the business from the current owners. This is a high risk situation and we would not advise following this course of action unless a viable business proposition has been identified and there is evidence of why an employee led organisation would succeed where others had failed.

• Privatisation – In the current economic climate it is common for government to seek to sell public sector enterprises to the private sector, to reduce the burden on the public sector. An alternative option to a trade sale or a float is a sell off to the employees of the business.

A willing buyer

Every employee buyout requires a willing seller and willing buyer. In situations where a trust will be used to own the business post buyout, and employee investment isn’t required, it is quite possible for the Board of Directors to make a decision about whether they are willing buyers and wish to complete a deal.

However, where employee investment is required there are a number of reasons which will determine whether employees will want to buy the business:

• Whether employees believe an employee buyout will preserve their employment post buyout? Will the employee buyout keep the business and jobs in the existing location? Would this be the case if the owner opted for a trade sale or liquidation?

• Is their a collective belief that the business is viable and can continue to be so? Does the business operate in a vibrant market place? Do customers need the product/service? Are there opportunities for expansion/diversification?

• Is there trust in the people who will lead the business post buyout? Do they have the ability to make the strategic and operational decisions required? Will they embrace the ideals of co-ownership and co-operation?

These are critical questions that employees will want to answer prior to making any decision about investing their money.

Board of Directors / Management team / Individual capable of leading the business when the owner exits

Ultimately either a group or an individual will need to convince employees and/or financing institutions that have the capability to manage the business in an independent environment, and to provide sufficient returns on the finance provided by the employees or institutions.

There is no guarantee that a Board or management team which has been effective in running the operations of the business will have ability or desire to cope successfully with the strains of management and ownership following a buy-out. Therefore it is essential to ensure the recognition by all people of a leader within the group to control the day to day operations of the business. Often this can require development plans and the use of consultants to enhance leadership skills.

An employee buyout changes the dynamic between management and employee in that the employees will be the owners of the business and the managers and employees are in effect working for their combined interests. This change in dynamic often requires a change in work attitudes of the employees. The goal should be securing the future rather than making short term profits. There needs to be a readiness to accept the attitude that the survival of the business depends on every single employee, and not just the workers or the managers.

Ideally, a Board of Directors and/or management team in a co-owned business will be one which:

• is value driven and clear about the direction the business should be taking;
• is strong in each key business area;
• has a proven ability to make the business perform;
• is keen to share information, encourage ideas, rewards and recognises good work;
• works together for the collective good;
• understands that with responsibility comes accountability.

A financially viable proposition

There are two key factors that must be present for an employee buyout to be a success:

1. Reasonable purchase price
2. Strong cash flows

An employee buyout won’t proceed if the purchase price is excessive and not possible to fund. An excessive purchase price will require either an upfront cash outlay from employees, financing from institutions, or a mix of these. Subsequent interest payments could place too much pressure on cash flows, with the result that the business will fail. The business must have the ability to generate cash flows sufficient to enable the repayment of debt, and provide a satisfactory return on equity.

The need to reduce the initial high level of borrowings inherent in buyouts means that the generation of a strong cash flow is of paramount importance. The cash flow should be reasonably predictable and not immediately absorbed into providing working capital finance (ie. finance for day to day activities) due to the cyclical nature of the business or an uncontrolled rate of expansion. A high level of fixed asset expenditure due to a lack of investment before the buy-out can also place pressure on the cash flow.