Four years ago I made the decision to turn the animation studio I founded, IdeaRocket, into an employee-owned company. The plan? To give away a third of the company to the employees over the decade or so till I retire, then have them buy out the remaining two-thirds over the first 15 or so years of my retirement, using the Company’s net revenues to do so. So far, it has been one of the best decisions I’ve made in running the company.
There are many kinds of employee ownership: VC-funded tech startups usually offer stock options to their employees. This helps them attract talent by offering a taste of the upside. Other firms use phantom stocks or profit-sharing plans to give their people a share of the spoils. I hope to write about these various forms of employee ownership at a later point, but today I want to write about using employee ownership for the primary business purpose of creating an entity that can buy the company from you.
Create a Buyer for Your Company
In many instances, your employees might be the most logical buyers for your company.
In our company’s case, there’s a reason why creative services firms like IdeaRocket aren’t easy to sell. Buyers are looking for sustainable value. Since a creative services firm doesn’t depend on intellectual property or infrastructure, what sustainable value mainly means is recurring revenue. Sadly, we’re in a sector that usually doesn’t have much recurring revenue – it’s more of a transaction-based business. Buyers of businesses don’t love that.
This is not to say that professional services companies, like IdeaRocket and many others, don’t have value. We have the brand equity we have built over years of operation. Also, we have organizational equity – that is, the institutional know-how that no individual member of the staff has in their heads entirely: a set of procedures and relationships that have been refined over years in a way that is not easy to replicate. Here’s the nub, though: since this value requires the adherence of insiders to be fully unlocked, it is inherently more valuable to insiders than to outsiders. Is your company similar to this?
If so, there are a number of options to selling to your company to employees:
- Perhaps your employees have the capability to raise funds to buy the company from you.
- Perhaps you could sell the company on credit to an employee group. An ESOP is a common and tax-advantaged way to do this.
- Or perhaps you could sell equity to the employee group slowly, giving you upside if your stake becomes more valuable over time, or downside if it loses value.
It is the latter option I intend to take, but of course it is not the best choice for everyone. Also, it is not the only advantage to employee ownership. Employee ownership can bring a number of boons to your business, before you cash out.
A Culture of Ownership
When an employee owns a stake in their company, they start behaving like a company owner. They have a stake in the success of clients and they want them to come back. Without exception, I see that attitude in all our staff. Frankly, I don’t think we had it before the ownership plan kicked in.
Of course, it didn’t happen all at once. I don’t doubt that a bad hire in an employee-owned company would still be a bad hire, but I’m convinced it has made a positive difference to our culture. If you would like your employees to behave in the best interests of your company, one of the most powerful things you can do is align their personal interests with company interests by giving them ownership.
Once you have a solid team in place, retaining them in their roles is important because both recruiting and training are expensive. Employee ownership, and particularly a plan that grants increasing interests to employees over time, are an excellent incentive to long-term commitment.
Have you met anyone who has sold their company to an outsider? I’ve met a few. There’s usually some pride, but there’s usually a sense of loss as well. They gave up their baby for a payout, and yes, this is what success looks like, and yes, now they are free to start another enterprise or do whatever else they want to do with their lives – but you can tell from the look on their faces… it’s complicated. They have mixed emotions.
Today, I’m driving IdeaRocket. Sometime not long from now, I would like to take one hand off the wheel. After that, I would like to take both hands off the wheel and scoot over to ride shotgun. Perhaps there is still something I can offer at that stage: a chairman-of-the-board sort of role, emeritus adviser… or perhaps I’ll just cheer from the sidelines. Eventually I will cede control, but the idea of weaning myself off running the company this way seems a lot more appealing to me than letting it go all at once.
Eventually, I would love to see the team I work with now succeed above and beyond what we have been able to achieve thus far. Which is to say: there is a distinct emotional advantage to selling to your employees.
Of course, there are also some reasons you might not want to consider Employee Ownership.
Sometimes, you need the payout of a sale to take the next step in your life. Maybe you’re looking to grasp an investment opportunity, to pass on wealth to your heirs, or maybe you’re a serial entrepreneur and are hoping to start a new company. If that is so, and your employees don’t have the capability of raising capital, then selling to an outsider for a payout makes sense.
Sometimes what an outside buyer brings isn’t just money. Sometimes they have expertise, connections, personnel or properties that will sing when joined with your company. If there is a synergy that can unlock value and a buyer is willing to pay for it, why fight business logic?
It’s Not Necessarily Simple
Setting up the legal entities to create an Employee Group is not an automatic. It requires a fair bit of legal work and a significant investment of time in communicating with employees. In addition, your bookkeeping and tax preparation might become more complicated.
Also, to truly welcome your employees as partners will mean sharing information with them as partners. If you are not comfortable with opening your books to your employees, this might not be the best move for you. However, I’ve found that radical transparency can help you get buy-in when times get tough and you have to tighten your belt. When you treat your employees as adults, they tend to behave as adults. If you treat them like children, they will likely behave that way too.
If you are a company owner and would like to discuss the possibility of selling your company to your employees, reach out and I will be happy to chat about our experience.