To get the best possible outcome on an exit event, you will need to ensure that your business is performing at its peak - right before the exit event, and often for a period of time after completion (eg where earn-outs are involved).
This is not something you can achieve without the support of a highly motivated team.
Business owners implement employee share schemes as a key part of their exit strategy, usually years before the planned exit event.
As explained below, an employee share scheme can be a powerful way to attract high quality talent, retain key people and ensure that all of the key stakeholders in your business are motivated to behave in ways that will maximise the value of the business, whenever an exit occurs.
1. Attract high quality staff
Not all companies are willing (or able) to offer meaningful equity incentives. This creates a clear differentiator for those who can. Many high quality managers - particularly those from larger companies - will not be interested in exploring a new role unless an equity stake is part of the offer.
Keep in mind that employee share schemes can vary in scale. Although participation is sometimes open to all employees, it is more common for participation to be limited to a small number of key employees. (We have prepared schemes in the past where there has been only one participant.)
The size of any employee share scheme should be determined by reference to the size and nature of the company, and the objectives of those implementing it.
2. Retain key management team
Just as important as your ability to attract high quality people is your ability to retain them.
Employees are more likely to think twice about leaving if they stand to walk away from something valuable, particularly if they know that an exit is on the horizon.
You will already be aware of the efficiencies that flow from a stable group of core managers.
Many buyers will be willing to pay a premium if they can see that there is an established management team who can operate the business effectively, independently of its owners. The ability to show a prospective buyer a picture of sustained performance by the same employees over a period of time can add significant value to your business on exit.
Also keep in mind that, when an exit occurs, some buyers will require that part of the purchase price will be a function of the business's performance for a period of time after completion. It is not uncommon to see employee share schemes adapted, or new schemes put in place, to ensure that key people continue to be incentivised through the transitioning of the business to its new owner.
3. Change the way your people think and behave
Equity incentives can be an important tool, not just for team retention, but to also ensure behaviours align with the achievement of your ultimate business objectives.
When designing your scheme, you can tailor the incentives to suit specific objectives. For example, if you are merely trying to promote staff retention, incentives may be provided based on staff tenure. However if you are trying to achieve objectives for the business as a whole (or perhaps specific parts of it), specific metrics can be incorporated into the scheme.
Employees who own a meaningful stake in a business will typically think and behave differently to those who do not, especially if there is a clear strategy for achieving the company's objectives and if there is clear vision for the company’s future. Businesses with greater employee ownership are typically able to demonstrate improved employee commitment and engagement.
It goes without saying, but the bigger the stake, the greater the incentive, and the more likely it is that employees will be motivated to achieve the goals set by the controlling shareholders.
4. Create or expand opportunities to exit
Usually the value of an employee share scheme lies in increasing the value of the business as a whole, thereby improving the return to all shareholders when an exit occurs.
However sometimes an employee share scheme can be used as a more direct way to achieve an exit.
An employee share scheme can be used to create a market for the owners’ shares where buyers may otherwise be hard to find.
Alternatively, even where potential buyers may be easy to find, an employee share scheme can sometimes be effective to:
- create a pool of buyers who may be interested to pay more than market value for the balance of the shares (with or without the assistance of third party or vendor financing); and/or
- create competition between potential buyers, thereby increasing the likely exit price for the current owner(s), regardless of the type of exit event that is ultimately pursued.
The process of considering a share scheme requires a careful analysis of your commercial objectives. Employee share scheme tax rules will also play an important role in the design of your scheme, and you will need the support of a specialist advisor in this area.
There are different ways to structure an employee share scheme, with share schemes, option schemes and phantom schemes being the most common. Employee option schemes are particularly attractive for companies with ambitions to achieve an exit within a certain period of time.