The term “financial freedom” has been used by the employee-owned community for a few years. It’s a momentous day for an employee-owned business when it pays its last pound of debt to its former shareholder(s).   I first heard it when “The 1:1 Diet by Cambridge Weight Plan” celebrated their financial freedom on Employee Ownership Day in 2018.  They marked the day with a big celebration, covering everyone in golden confetti; it was clear how much the day meant to them.

Not all businesses find themselves in the same position on “Freedom Day”, however, there are a few things  that all employee-owned businesses should think about when approaching this milestone.

Administration

After the last payment to the former shareholder(s) has been made; there may be some admin that needs to be done:

• If the former shareholder(s) had a security over the assets of the Company, this can now be released as the debt is repaid in full.
• If the former shareholder(s) held a preference share in the Company to protect their interests while the debt was owed, this can now be redeemed.

Changing Governance

The end of the debt repayment period often results in changing relationships within the business and a change in where the control sits.

• Any creditor rights that the former shareholder(s) had that were linked to the debt should fall away; potentially giving the board more freedom in its operations.
• The former shareholder(s) right to be on the Company Board and/or Trust Board may also end.
• Where former owners hold a retained shareholding, their relationship with the business may not end, but will be different as the EOT holds a majority of the shares and the creditor protections fall away, and their role is now that of minority shareholder.
• Where there are EMI options in place, on their exercise, there will be a new generation of minority shareholders. It is crucial to understand if they have a role in governance (i.e. if the shares have voting rights), or if the EMI scheme is a method of financial reward.

It is important to be aware of what these changes in governance and control mean for the business and its stakeholders.  When these changes happen, it is a good time to review your governance as a whole and consider how things should work, day to day, year to year, and to ensure the business has robust structures in place in a crisis.

Financial Considerations

The financial position of businesses after the debt to the former Shareholder(s) is repaid can vary from business to business.  This can depend on how the repayments were structured, business performance over the period, and the financial pressures on the business moving forwards.  For many there can be a need for consolidation, to rebuild cash reserves or make essential investments within the business.

Common considerations include:

• Does the business need a period of consolidation to rebuild working capital?
• Is there a need for investment or to progress projects that have been put on hold during the repayment period?
• Are there EMI options in place? The repayment of the debt is often the trigger for these to be exercised and sold back to the trust.  What will the Company’s obligation be to fund these purchases over the next few years?
• Are there retained shares? What is the long term plan for these?  Should the company be planning for the buyback of these shares or will they be held for the long term?

A Fresh look at Reward

Once the former shareholder debt is paid in full, profitable EO businesses are able to take a fresh look at reward.  Some may already have an agreement as to how profit will be shared, but many do not.  Employee owned businesses usually have far more flexibility as to how they incentivise and reward employees; however, it can be difficult to know where to start – especially after being focused on paying down the debt to the former shareholder(s) for several years.

A good starting point might be:

• Understand who makes the decisions around reward. This will often be the Company Board, with oversight from the trust, but not all employee-owned businesses are the same.
• Consider what your objectives are – what are you trying to incentivise?
• Does any proposed structure support / promote your culture of ownership, can employees relate their reward to their ownership of and contribution to the business?
• Are your key people incentivised in the right way?
• Are there non-financial rewards that might be meaningful to your employees and support a culture of ownership.

Employee owned businesses owned by an EOT are also able to introduce share schemes to allow employees to own shares directly although this is not for everyone. However,  if you feel these might work for you, we have articles on EMI Schemes and Share Incentive Plans (SIP), which discuss the use of these schemes in more detail.

Employee Ownership Culture

Financial freedom is an important time to consider the ownership culture that has been built in the business since the transition took place, reflecting on the progress that has been made, and identifying areas for improvement.

Implementing an employee ownership culture isn’t a linear journey with a beginning, middle, and end – it’s an ongoing process.

Paying the last pound of the debt is a significant milestone for everyone; just like the day the business became employee owned.  At Baxendale Employee Ownership, we are experienced in helping businesses explore all these issues and more. So, if your business is looking for help and advice, please do get in touch and see how we might be able to help you.

If you would like advice or an informal chat on any of the issues covered in this article, contact Emily Alston emily.alston@baxendale-eo.co.uk

Emily Alston