Contact

Worker Cooperatives

Empowering Workers Everywhere

Home|About|Contact|FAQ|Buy/Sell Business|Blog|Facebook
Education|Startup|Conversion|Services|Pricing

Converting Traditional Companies to Worker Cooperatives

Table of Content

Introduction
Traditional Succession
The Alternatives
Reasons for Converting
Selling to employees is safer than traditional methods
Is Converting Right for Your Business?
The Process
Are You Ready?
Is Your Company Ready?
Are Your Employees Ready?
Getting Started
Letter of Intent
Due Diligence
Contract

Introduction

Thousands of small business owners will be retiring in the next decade or so. Who will take over? Future generations of workforce age are much smaller in number. The result could be a great deal of consolidation. Some small businesses may be absorbed by larger competitors. Others may simply close their doors.

Few retiring owners have given much thought to how, to whom or when they will exit. When they do retire, they are likely to leave behind a legacy of closed businesses and lost jobs. The damage is not limited to the people directly involved. Whole communities are impacted as well. New owners are more likely to be living somewhere else. They will spend their money there transferring wealth out of the local economy.

Fortunately, there are solutions.
Table of Content

Traditional Succession

If you belong to the minority of business owners who have thought about retirement, you have probably considered one of the three most common ways to transfer ownership to a successor.
  • Selling to family member(s)
  • Selling to an outside buyer
  • Selling to one or more managers
Keeping it in the family used to be the most common succession path for small business owners. There may be many reasons for this, but the reality is that it is a shrinking portion of all the transitions.

Almost all other sellers have at least considered the possibility of selling to an outside buyer. This is no big surprise since this option comes with some advantages that are important to many sellers. It is also surrounded by a great deal of myths, and only a small number of those who try, actually succeed.

It may be a bit more surprising that selling to one or more managers is the most common way to continue a business. Some consider this a Plan B, but this option actually comes with its own set of advantages for both sellers and buyers.

Of course, there is also a fourth option: Liquidation, but that is not really a succession since it effectively ends the business. When traditional succession options fail, owners sell off the assets and close their doors. The result is a loss of jobs and community wealth.
Table of Content

The Alternatives

Faced with job loss, the employees suddenly become the best buyers to take over the business in order to maintain their livelihood. There are at least three forms of employee ownership:
  • Employee Stock Ownership Plans (ESOPs)
  • Employee Ownership Trusts (EOTs)
  • Worker Cooperatives
Employee Stock Ownership Plans have been around since the mid-70s when they were formally included in the Employee Retirement Income Security Act (ERISA). They are complex and heavily regulated. As a result, they are usually not an option for very small businesses. Among the greatest benefits are the tax advantages for both owners and employees.

Employee Ownership Trusts have only come onto the scene quite recently. In the past, trusts have usually been used in family transitions, but can also serve as a way for transitioning to employee ownership. They are quite simple to set up so just about everyone can participate. The main advantage for the owner is the ability to maintain control until the company has been fully paid for.

Worker Cooperatives are still rare in the U.S., but common in Europe. For owners, they come with tax advantages similar to ESOPs, but like trusts, they are free of the many regulations making them a viable option even for very small companies. For the employees, the biggest advantage is that they are democratically governed giving them control of their work environment.
Table of Content

Reasons for Converting

Different people have different motivations for what they do. For most, one of the biggest motivations for selling the business to employees is to preserve perhaps a lifetime of hard work building it. Perhaps they regarded it as a way to build enough wealth to provide a comfortable retirement. Transition to employee ownership is the best way to meet these goals.

Faced with possible unemployment, employees are the most motivated buyers of all. Combine that with the possibility of being able to defer capital gains perhaps indefinitely and avoiding a hefty broker commission, selling to employees could bring the best net result of all the available options.

For some, being able to exit immediately with a large cash payment is desirable, but usually not likely. For others, being able to retire gradually while having something meaningful to do is more important. For the latter, gradual transition or transition in stages is as close to ideal as it gets. Transitioning to employee ownership does that very well.
Table of Content

Selling to employees is safer than traditional methods

First, employee owned companies tend to be more resilient than others. The consequences of failure could be devastating for them and their families so they will go out of their way to preserve their jobs. As a result they are more productive and profitable.

Second, they may be able to repay acquisition loans with pre-tax dollars making debt retirement easier than traditionally owned companies. As a result, sellers are more likely to be paid in full.
Table of Content

Is Converting Right for Your Business?

The basis for a successful transition is the willingness of both sides to make it happen. Some of the considerations are: After the transition is complete, your employees will be the owners. As such they should behave like owners. They will need to have access to every detail of the company’s financials just like you do now. They will be electing the company’s Board of Directors. They should take an active part in the management of the company. Most likely, they are not currently doing any of those things, but may be at some level on the scale of participation from none to fully participating. Can they be brought to that level?

Do You Have a Strong Management Team Already in Place?

Just because ownership changes and control becomes less hierarchical, it does not mean that the new company does not need leadership. In fact, they will need even more leadership because of the added overhead of democratic control. Have you or can you transfer your leadership role to existing management staff? If not, what will it take to do that?

Are You Prepared to Take the Time it Takes to Complete the Transaction?

In most cases, the transaction involves creating a new employee owned entity to purchase the assets of your company. Unlike an outside buyer, the employee owners will first have to get used to the idea and get organized as a company. That could take some time. A study will have to be undertaken to verify that this will indeed satisfy the needs of all parties, buyers as well as sellers. That will take some time as well.

Is the Company Healthy Enough to be Transferred?

Worker cooperatives do not need to make huge profits, just enough to pay their members a decent wage. If the company is not healthy enough to do that and to service any acquisition debt, it may not be a good candidate for worker ownership. Worker ownership is not meant as a vehicle for turning around ailing companies. At least some seller financing is expected and you want the new company to be able to meet that obligation.

Are You Willing to Work Honestly and in Good Faith Toward Common Goals?

You may have spent the better part of a lifetime building your company. No one will fault you for trying to maximize your reward for doing that. If you think you can get a better price from an outside buyer despite the tax incentives selling to your employees has to offer, then you should do that. What we do expect from you, is that, in either case, you will deal fairly and honestly with everyone involved with your common goal of a seamless transition in mind. The transitions no one notices are the most successful ones.
Table of Content

The Process

The transition to employee ownership is almost always initiated by the seller. Therefore, let us begin with the seller.

Almost no business owners have exit plans. The demands of running the business consumes most of their energy and exit planning gets pushed to the backburner. It is never too early to begin thinking about these things.
Table of Content

Are You Ready?

Before you give up what has likely occupied your mind more than anything, you will have to make four key decisions:
  • When will you retire?
  • What will you do when you do?
  • How will you live?
  • Who will take over?

So, first try to answer the four questions for yourself. Then, think about how others in your immediate family will react; how they will be impacted.

At some point, you will need to have actual conversations with them. If your only concern is your spouse, it may be relatively easy. If you are concerned with the impact on a large group of extended family, you may need to seek professional assistance. Family transitions have a tendency to become complicated and easily spiral out of control. A neutral third-party may be just what you need.

When Will You Retire?

More than likely, you are already approaching that time and preparing for it is probably overdue already. As you read on, you may realize that it takes more time than you anticipated. All is not lost, however, but do get started planning today while you still have the capacity to do so.

What Will You Do?

Running your business may have been your passion for a very long time. It has consumed most of your time. You may have few outside interests. If that is the case for you, it is critical that you develop other interests. You do not want to end up in the group of retired business owners who, bored out of their wits, see no other option but to start another business just like the one they just sold. Again, if running your business has occupied most of your energy, there is a good chance that accumulating retirement funds outside your business has been neglected. If you are just starting out, it is OK to want to invest all available funds in it. Once you have reached a level where it can comfortably cover your living expenses, it is time to diversify and earmark something for retirement outside your business. If you are close to retirement and you have not done so yet, it is time to call a financial planning professional right away.

Who Will Take Over?

There are six different ways to sell your business:
  • Family member(s)
  • Outside buyer
  • Management team
  • Employee Stock Ownership Plan (ESOP)
  • Employee Ownership Trust (EOT)
  • Worker Cooperative
Family transitions used to be common. Now only about 5% make it to the third generation.

There are two types of outside buyers: Strategic and financial. Strategic buyers typically already have a business and they think yours will be a good fit for it. Maybe you have something special they find attractive and they will pay you a good price for it. This is rare, but it does happen. This is the type of transactions that sometimes makes the news. You will hear that this large corporation has acquired another. Financial buyers typically plan to operate the business themselves just like you did. Regardless of what business brokers will tell you, only about one in five businesses listed for sale actually sell.

Selling to a management team is actually the most common of all the transition methods today. This is where a small group of employees, typically the managers, buy the company from the owner. There are two types: Regular buy-out and leveraged buy-out. The difference being whether third-party financing is used.

All these usually provide for a relatively quick exit for the owner. Sometimes, but not always, as when the owner finances some of the sale, some risk is involved.

Selling to employees usually takes longer and is ideal for owners who want to remain involved or who wish to protect their owner financing interest.

Employee Stock Ownership Plans (ESOPs) are complicated and heavily regulated. They are mostly suitable for larger companies. The benefits, however, are numerous and getting started early will maximize those benefits. The net result might easily compete with a favorable offer from an outside buyer.

ESOPs are essentially retirement plans for the employees who over time could end up owning 100% of the company if desired. An ESOP is an example of indirect ownership. Employee owned shares are being held in individual accounts by a trustee appointed by the owner. One advantage for the owner, therefore, is that he/she can maintain control even after the sale has been completed.

Because trusts do not pay tax on their earnings, unlike the case of a management buy-out, all of the earnings on employee owned shares can be used to buy more shares on their behalf.

Employee Ownership Trusts (EOTs) are relatively newcomers in the US and do not enjoy all of the tax benefits associated with ESOPs and worker cooperatives. EOTs are another example of indirect ownership. The shares are also being held in trust by a trustee appointed by the owner, but not necessarily in individual accounts. Again, the owner can maintain control and earnings can go 100% towards debt retirement.

Unlike an ESOP, EOTs do not have retirement features. Therefore, they are far less complicated to set up and accessible even to very small companies.

Unlike, ESOPs and EOTs, worker cooperatives are owned by their employees directly. Everyone owns one equal share and everyone has one vote. They are not heavily regulated and are as easy to start as any other company.

The challenges lie in the democratic governance, unfamiliar territory for most employees without prior exposure. The biggest challenges for transitions from traditional ownership to employee ownership are financing and transfer of control.

Traditional lenders are unfamiliar with the unique ownership structure of cooperatives. Fortunately, there are non-profit funds specializing in this type of lending. Combined with buyer and seller financing, a solution can usually be accomplished.

Because seller financing is expected and the sale usually effected in stages, the owner may be allowed veto power in certain types of decisions or have a seat on the Board of Directors until employee ownership has reached a certain level depending on how his/her role is defined in the new worker owned company.

The challenge for the owner then becomes to develop the best case scenario, the ideal retirement for him/her and his/her family. With the ideal in view, it is time to look at what is actually possible.
Table of Content

Is Your Company Ready?

Some business owners have made arrangements to accumulate enough funds outside the company to be able to retire comfortably. Others will rely on the proceeds from a sale for some or all of their needs. If so, maximizing the sale price becomes very important. There are a lot of things you can do to enhance the value of your company. Here are some of the things buyers will be looking for. Every step you can take to give them what they want, the closer you will get to meet your goals.

All buyers, employees as well as others, will examine your company in great detail to make sure they get the value they expect and that the purchase will satisfy their long term goals. The number one thing they will be looking for is management.

The Seller

Before you can transfer your company to anyone, you will need to extract yourself from the company physically, financially and most importantly, emotionally.

Physically

If you are a one-person operation and the business totally depends on your presence every day, there really is not much you can transfer except perhaps a customer list and some equipment. Unfortunately, some business owners even with many employees operate the same way. They think they need to be involved in everything for it to be done right. Again, there is not much you can transfer to anyone if the operation depends on your presence. To maximize the value, you need to turn your business into a turnkey, owner independent or absentee owner operation.

The mechanics of documenting every procedure, writing step-by-step instructions or guidelines is the easy part. For many, the biggest hurdle, will be to mentally prepare for this process, but it is necessary.

There are other benefits as well. The quality of your product or service will be more consistent. Your business will continue to generate income even if you become incapacitated or you simply want to take a day off or two.

Financially

It is common for business owners to purchase various items for personal use with company funds. That needs to stop at least a few years ahead of the target date.

You may also need to adjust your compensation to align with what it would cost to hire your replacement.

Emotionally

For some, the exit cannot come soon enough and it will be time for celebration. For others, it is more difficult and in different ways whether it is a clean break or it happens over time.

Other Value Drivers

Management

With the owner gone, on a gradual exit and perhaps no longer 100% engaged, every buyer will pay a lot of attention to how the company will be run in the future. A dedicated management team capable of growing it further will be at the top of their wish list. If no one is available to do that, perhaps some strategic hiring well ahead of time will be necessary.

Increasing Revenue and Profits

With a solid and dedicated management team in place, revenue and profits should be on a steadily upward trajectory. If not, it is time to find out why and make some adjustments.

Systems and Processes in Place

The best transitions are the ones no one notices, but there are always some risk involved in a transition. For example, employees, who were perfectly happy under the old ownership, may find the new ownership intolerable and decide to jump ship. If you can show a buyer that you have fully documented systems and procedures in place so that anyone can easily take over, he/she will see that the company will continue to perform until a replacement can be found and that the risk is minimal.

Clean Financials

Accurate and meticulous bookkeeping serves at least two purposes. First, without it you would not know whether you have reached your goals or not. Second, it is used for reporting to various government entities.

If bookkeeping has been neglected or if you have mingled your personal finances with your business, it is time to hire a professional to get that cleaned up. You will need to show at least a few years of accurate bookkeeping.

Every buyer will want to know that the company has a product or service that is in demand. They will want to know that the demand will continue to be present, that sales are strong and independent of the owner’s presence.

Every buyer will have his/her own priorities. The more of them you can address while there is still time, the better.

Business Evaluation

Business evaluation is not an exact science. There are lots of factors that are difficult to assign a definite value. Business owners tend to be visionaries. They are willing to take risks others would not. As a result, they are often quite unrealistic about the value of their company, perhaps even in denial. Ultimately, the buyer is the one who will decide what he/she is willing to pay.

Even with a completed evaluation in hand, it is advisable to accumulate most or preferably all of the funds it takes to retire. The last thing you want to have happen is to have all your funds locked up in an illiquid asset like your company.
Table of Content

Are Your Employees Ready?

If your employees are your chosen successors and they have chosen to be organized as a worker cooperative, chances are that they are ill prepared. Some kind of transition period will be required.

We live in a democracy and it is easy to assume that everyone knows how that works, but that is just not the always the case. At some point, all of us have been at meetings that just disintegrated into yelling and chaos. Fortunately, there are professionals who can help with that.

As owners you are suddenly responsible, both individually and as a group, for how the company performs. Not everyone will have the capacity to be leaders and not everyone needs to be. However, everyone’s paycheck depends on how the company performs. The better everyone understands their individual role in making that happen, the better off everyone will be. So a minimal understanding of how the company does financially is very important.

Of course, you cannot begin to address any of these issues until a decision has been made that employee ownership is the best possible solution for everyone, so you will need to set aside some time for that.
Table of Content

Getting Started

You do not want the news of your intentions to reach competitors, customers or suppliers just yet. They may begin to take unexpected and adverse actions, so you want to limit all conversations to family and trusted advisors. Once you are convinced that selling to your employees is the best way to exit, you will have to start the conversation with them. They may be turned off when you ask them to sign confidentiality agreements, but this is necessary.

Once you yourself have a clear understanding of how the transition could be structured, you need to present it. You might want to hire someone to do that for you.

Depending on the size of your group, you might want the employees to elect a steering committee. Things will move a lot smoother that way. They will obviously need to discuss your proposal among themselves and it might be useful to hire a facilitator to lead those discussions.

If they agree to pursue this outcome, they will conduct a feasibility study to make sure that the company will actually survive and their goals to keep their jobs and to have income are actually met.
Table of Content

Letter of Intent

Once the employees have decided that your plan is worth pursuing, you will both sign a so-called Letter of Intent. It basically just summarizes what is proposed and sets a timeframe for completing the deal.
Table of Content

Due Diligence

First, the employees will want to verify that what they are buying is as valuable as you say it is. They will hire their own advisers to do that, preferably some who are familiar with the concept of worker cooperatives. This is similar to a home inspection when you buy a house, just more complicated.
Table of Content

Contract

In order to sign a contract, the employees will need to form a new entity, elect a Board of Directors and appoint officers. It may take some time to work out the details of the by-laws although much of the discussion may have already been completed in the earlier stage.

Once the contract has been signed, a lot of activity will take place to obtain third-party financing, prepare to transfer patents, licenses, etc. Finally, once everything has been lined up, the closing will officially transfer ownership.
Table of Content

Latest Articles

Startup

Do Not Start Your Own Business

Best Industries for Worker Cooperatives

A Freelancer's Guide to Worker Cooperatives

Conversion

Is Your Business Salable? Is it Profitable?

Would Your Employees Want to Buy Your Business?

Interview with David Barnett

Emotional Retirement

Can Your Business Run Without You?

Convert Existing Business

Do you have an exit plan?



Finn Mauritzen is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.