Businesses aren’t all the same.
Some are not well suited to being controlled by an Employee Ownership Trust. We discuss key features making a business unsuitable in this post.
We’ve written a separate, contrasting post on key features of a business that IS suitable for an EOT here.
Founder focussed on maximising cash
Whilst Employee Ownership Trusts can pay you fair market value, tax free, it often won’t be the most lucrative option for the founder, especially in the short term.
Normally the most financially lucrative option will be a trade sale, to a strategic buyer. Someone with deep pockets, who really wants your company. When combined with their existing business(es), they believe 2 plus 2 can equal 5 (or more!).
Founder wanting significant up front payment
This might not appeal for two main reasons:
They need cash now
Perhaps their mortgage term is ending, and due to their age they can’t extend it.
Or a family issue needs significant cash now.
Whilst cash rich EOTs can make sizeable up front payments, and/or a lender can potentially be sought, it’s still normal for founders to be drip fed payments over multiple years.
Risk to their payments
With any business sale, cash up front is king. In trade sales there’s often a contingent, deferred payment. Whilst some people may say we’re overly cynical on this, it does seem a lot of buyers will always try to find a way to wriggle out of these. Hence you run the risk all you get is the up front payment.
Whilst it’s harder for successful EOT owned company to wriggle out of paying their deferred consideration, the business may fail. If it does, no more profits, meaning no more payments to the founder.
Hence it can be nerve-racking for a founder to sell to an EOT. They’re reliant on the business continuing to do well for multiple years, after they’ve given up control.
Companies with value not from cash/profit
Companies can be valuable for lots of reasons/in lots of ways.
A business making reliable profits is one way. These kinds of businesses can work well with EOTs.
However some businesses make losses year after year, but are still deemed very valuable. Why/how?
“Silicon Valley”esque unicorn
A business that’s growing exponentially. It’s burning through cash, losing money month after month. But investors are happy to throw more and more money at it, to own a tiny stake. They’re buying potential.
There will be belief that whilst the business is loss making now, at some future point (possibly many years away) it could become hugely profitable.
Many software companies will be like this. The theory is it’s expensive to develop the software, and initially you have minimal users. But if it becomes very popular, income can rocket, whilst the cost of each extra user is negligible.
Valuable non-cash balance sheet assets
Maybe the business has valuable buildings, like a hotel chain that owns the properties. Or a vehicle rental company, with lots of cars/vans on the balance sheet.
The business may be very valuable, but often not that easy to get large amounts of cash to the founder.
There may be some options. Eg if a hotel chain owns the buildings outright, they could look to mortgage them. The vehicle rental company similarly may be able to get a big loan based on the vehicle values.
Firstly this will only work if the companies aren’t already heavily in debt (perhaps the founder already leveraged their assets heavily to maximise growth).
Secondly it raises risk for the business. The company now has big interest payments to make that it didn’t have before.
Intellectual property
Imagine you’ve just invented some amazing new product, and got a patent for it. You don’t have any particularly great usage for this product at the moment, but you know a few other businesses do.
One of those businesses may be prepared to pay a huge sum for your company, so they’d then own the intellectual property.
An EOT sale won’t help here, unless your own business can find a way to make significant profitable usage of the intellectual property itself.
Founder is critical to the business
We sometimes hear founders proudly say “my business would fall apart without me”. It boosts their ego. Maybe everyone else in the business is dispensable, but not them.
Unfortunately this isn’t the positive some people think it is. This tends to become obvious when you start to think about exiting. If it can’t cope without you, how are you ever going to be able to leave?!
We wrote a fuller blog post re founders being essential to the business here. In short, where it’s true, it makes the business far harder to sell. This applies to a sale to any buyer, not just an EOT.
In some respects, it can be slightly less of an issue with an EOT sale. Why? Because the founder is more likely to be able to continue to work there long term than if a third party bought it.
On the flip side, there is an argument it’s worse for an EOT sale. Why? Because it suggests the leadership team in the business aren’t that strong.
Leadership team don’t want it
Everyone wants the chance to lead, right? To make big decisions, have everyone look up to them. It’s great, right?
No! Certainly not everyone feels that way!
It may seem obvious to the majority of humans out there, that many won’t want to lead. But if you’re a founder, you were typically in the minority who DID want to lead. Sometimes we mistakenly think everyone else is like us.
Founders will often choose brilliant right hand men/women, to work alongside them. A loyal and bright worker, keen to please the inspirational leader. This can work well.
However, this does not mean those workers will be keen to step into your shoes. We wrote an article about Terrified Terry, a brilliant right hand man, pushed into the limelight, and hated it.
At least theoretically an external person could be brought in to be Managing Director. However an EOT sale is a big change in itself. Adding in some random person right at the top of the organisation, at the same time, can be a huge risk.
Summary
Any business can sell to an EOT. But ones that are less suitable include those where:
- Founder heavily focussed on getting the biggest sale price, with as much up front as possible
- The financial value comes from quirky assets/crazy growth, not cash/reliable profits
- Founder essential to the business itself
- Leadership team aren’t up for it, or up to it (or both!)
None of the above individually prevent an EOT sale from being done, or even from working. However, where they apply, it does raise questions over whether an EOT is the best option.
If you are interested in finding out more about transitioning to an EOT, get in touch with us at Go EO to see how we can help.