Business owners who spend time up front developing a clear vision for their company as an EOT often have a more successful outcome. Rather than worry about the technical details, it’s useful to envision what the future state looks like for the business owner, the company, and employees. For example, a business owner can ask themselves: 

• What are my personal financial needs following the sale of my business?
• What does the company need to be able to do to maintain its success?
• How involved do I want to be in the business moving forward, and for how long? 
• How should decision-making work inside the company as an EOT?
• What type of financial incentives will best motivate, retain, and reward employees?
• Will the transition  maintain or enhance the culture and organization?

While advisors can help a business owner evaluate these questions, clear priorities and a strong vision up-front will help navigate the decisions that need to be made as a part of an EOT transaction. This can in turn provide focus to your advisors and ensure there’s a customized approach that best fits the needs of you, your company, and employees. 

A company’s readiness for an EOT is based on a number of factors, but two are key: management readiness and financial performance. 

Regardless of whether or not a business owner plans to stay in an operational role post-transaction, eventually it will be important for the company to have identified and trained the next generation of leaders. In many cases, there will not be a single replacement for the former business owner. A business owner could be leading more than one function inside the company, which may require either hiring or training multiple leaders for a successful transition. There may also be a need to look not just to the executive team, but also to middle management to ensure there’s a strong bench. Ultimately a business owner will know what’s best for their company, and having the time to plan and execute this leadership transition can ensure the right talent is in place to navigate the decades ahead. While an EOT is a powerful ownership succession tool, it is not a management succession tool.

From a financial perspective, the most important planning step is to ensure the company has found a stable footing, with some predictability of future performance. If there’s a major contract, lease or other event that could dramatically alter the business, addressing uncertainty can be helpful before embarking on an EOT transaction. Not only will these elements factor into valuation, but it will have a significant impact whether the company can continue to thrive and successfully transition to an EOT. In addition, many closely-held private companies can have expenses that will not continue when the company is now EOT-owned. It can be helpful to begin this professionalization of the financial practices of the business in preparation for an EOT transaction. A trusted financial partner, such as your banker, can help you assess the financial strength of your company in advance of starting a transition.

The right amount of time needed to prepare for an EOT transaction will depend on each company. While in some cases it can be accomplished in a matter of months, it’s not uncommon for some companies to plan over multiple years. 

When it comes to external transaction advisors, there isn’t a one-size-fits-all approach. What’s important to consider when selecting advisors is having the right functional expertise and to properly manage conflicts of interest. 

For functional expertise, business owners will need an advisor or advisors with demonstrable experience in mergers and acquisitions, valuations, employee ownership, as well as legal, tax and accounting for EOTs. This expertise could come from M&A or valuation firms, lawyers, Certified Public Accountants, or other specialists. Your existing financial partners, such as your banker, often have internal resources or referrals to support you at this stage. Evaluate each advisor’s past transactions for expertise in these areas, as well as look for references from former clients. 

Any perceived or actual conflicts of interest must be eliminated prior to engaging an advisor.  You will want to be mindful of having fair representation for both the seller (the business owner) and the buyer (the EOT). More is not always better with advisors, especially when it comes to the impact on fees and transaction complexity. Trust between you and the advisors involved is an invaluable asset to ensuring a successful transaction. 

The management team will likely have an outsized role during and after an EOT transaction. Sometimes these executives will take on formal roles, such as a trustee or board member, other times they will play important informal roles ensuring the EOT is positively received upon roll-out. Trust in management’s ability to steward and grow the business is crucial for a successful EOT.

Finally, many EOTs will require an independent trustee or board member. You may not currently have a Board of Directors, which can make this change feel uncomfortable and formal. However, building a strong governance structure is critical to the long-term success of the business. When looking for an independent trustee or board member, it’s first important to make sure it’s clear what you’re asking of them. Hiring for an administrative role lends toward a different set of candidates than for a traditional Board Director, who often needs more experience in the industry or business in general. For a business owner who will remain significantly invested post-transaction, it’s important to find the right person to fill this role. 

There are a few elements to building a strong culture of employee ownership. The first is the design of the incentive program. Not all EOTs are created equal. The Federal Government has provided flexibility in how benefits are structured for employees. The design of the incentive program should promote long-term thinking and retention. For example, you want to be mindful about how employees will react to longer-term investments that may reduce the profit available to distribute to employees in the short-term. . 

The second is a commitment to workforce education. Employee ownership programs are often only as successful as how well they are understood by employees. Not only is it important to ensure that they understand how the benefits of ownership work and under what circumstances they are distributed, but also to ensure there are reasonable expectations on what it means financially and otherwise. 

The third area is developing an ownership culture. Every company will develop their own unique approach. Some companies practice open-book management, where financials (or elements of the financials) are transparently available to all employee-owners. Other companies will be more selective in the information they share, based on considerations such as trade secrets. A range of practices are also seen around decision-making and governance. Some companies will have employees on boards, others will have worker committees that interface with the board, and some have more customized approaches. What’s most important is that an ownership culture is developed that creates a sense of agency and open communication. 

An EOT is more than just a transaction for employees, it can be a lifechanging opportunity. Business owners make this possible, and can fuel employees’ excitement by empowering them with information and agency over time.  

Before explaining each point, it’s important to identify that there are typically two sources of financing for an EOT transaction. 

1. Third-party bank financing, which is often to the primary source of any upfront cash payout (or liquidity) to the business owner. Bank financing comes with interest and repayment requirements, and guidelines on how the company’s incremental cashflow is utilized. 
2. Vendor financing, which is provided by the business owner. There is significant flexibility on how vendor financing is designed, from the structure (eg. debt, equity-like features) to the expected rate of return.  

Upfront cash or liquidity is about more than just having spending money following a transaction. After a lifetime of sacrifice, business owners have earned the ability to consider the comforts of a more financially secure life. That may involve new purchases, paying down other debts (eg. mortgages), or diversifying their assets to provide a greater sense of security for their family. For business owners of larger companies, there may also be tax obligations beyond the EOTs capital gains incentive. Upfront liquidity is needed in all of these scenarios. Financing from a bank or other 3^rd party lender is often the only source of that upfront cash liquidity, and needs to be carefully evaluated. 

Whether bank financing is utilized or not, it’s important to design an overall financing strategy that allows for the company to continue to thrive and meet the demands of employee ownership. The capital structure should allow for future investments in growth, such as acquisitions or cap expenditure needs, as well as meets the obligations of ownership-related distributions to employees. Two key factors in ensuring this happens is maintaining a reasonable amount of 3^rd party (e.g. bank) financing and that vendor financing is designed to make use of the flexibility it can provide a company. Many vendor financing structures will have no scheduled payments, as an example, or utilize non-cash interest payments (payments-in-kind). Finding the right balance on these dimensions is important to ensuring the company can successfully repay debt and transition out the business owner. 

Finally, business owners should work with financing partners who are aligned to a shared vision for employee ownership and the long-term success of the business. It’s important that all parties are committed to creating a strong financial benefit for the future employee owners, and navigating any challenges that may come up along the way.