The most valuable asset of a 21st-century institution, whether business or non-business, will be its knowledge workers and their productivity.Peter Drucker
I used to hear that in my MBA studies and feel good that companies had understood the importance and value of their employees. I thought that this would translate into fair and equitable treatment and in sharing the value that is generated.
But rich people are still getting richer and our laws put shareholder value above a lot of other things.
And then I realised that the same is true for myself. I was the main shareholder of my companies and while I had been sharing profits with the team for a few years, they did not have any equity ownership in the business.
Starting With Myself
So instead of hoping for others to make changes, I decided to start in my own world. Despite some fear and wanting to hold onto the ownership in the business, I made it happen.
And now that my team owns over 60% of the business, it feels really amazing and like absolutely the right thing to do. We did it in a way that was not only good for my team but also really great for me. And I hope that many other business owners will consider this as an option to transition from actively running their businesses while rewarding the employees who have made all of this value creation possible.
How did we do it?
We effectively switched the employee profit share to equity ownership.
I then sold additional equity to those employees interested by giving them an interest free loan (vendor finance) with an agreement that all repayments will be made from future dividends/distributions. If the business fails before they have repaid the full loans, they won’t owe me anything (because effectively it means that we had not valued the business accurately).
So it was a totally risk free transaction for my employees.
What’s in it for me?
I was able to take advantage of the small business CGT concessions, very generous tax concessions for entrepreneurs, thanks to my accountants (a special shout out to Paul Meissner from 5Ways Group for creating this strategy with me).
There is one thing we had to manage carefully.
The dividends (or in our case distributions from a trust) to everyone are taxable as income in the year they are made. If 100% of distributions were used to repay the loan, the employees would have had to come up with the cash to pay tax on that income.
In our case, the equity from the previous profit share gives everyone enough cash for the tax payments on the whole distribution.
“Are you for real?”
When I first proposed this to my employees, I was met with dead silence. I think none of my team actually believed this was real. It just sounded too good to be true.
And then the first person said yes and others dared to follow. Since we had the first distributions a few team members regretted not taking advantage of the interest free loan more strongly.
So we actually have different levels of ownership now. It will be interesting to see how that plays out over time.
Valuing the Business
Anyone who has ever had their business valued knows that there are many different ways of doing that. As a relatively stable business with reliable returns, we just went for 4 times net profit. No external valuers involved, just keeping it really simple.
It also means that the loans are repaid in a manageable timeframe. In our case in about four years if the business keeps performing as it has in the past.
Could I have gotten more? Maybe, maybe not. But I definitely could not have gotten more joy out of seeing the business in capable hands, sharing the fruits of that labour with those who made this success possible and having earned a sufficient return for the work I put in over the years.
The Technical Process
- Valuing the business at 4x net profit
- 30% of that value represented the previous profit share. The team decided how to split that up equitably (they did it based on the weekly hours worked – part-time vs full-time). Anyone leaving the company before having been there for 5 years has to sell their shares back at $1, at five years, 50% can be kept forever, increasing to 100% at ten years.
- We set up a hybrid trust (so everyone has the benefits of income streaming) and distributed the correct units to every employee to reflect their share at no consideration.
- Additional units were offered for sale to reflect the agreed company valuation. I bought just under 40% of all units available.
- I lent money to my employees that wanted to purchase additional units and they purchased them.
- The cash equity that was now in the trust was used to purchase 100% of the shares in the company (in our case companies).
- And now the trust owns the companies and distributes to its members.
Am I Working 40% now?
In reality, I feel even more compelled to succeed with our vision and our plans. It is almost as though I am working harder now to deliver what I promised to my team.
I am lucky in that I have a team that keeps telling me to back off and let them do their thing. They don’t need me that much anymore. But I guess it is the same as with children: Now that they are growing up, it is hard to remember that they are quite capable and need a lot less of my input.
So after having given a large portion of the ownership to my team, I now need to let go of the responsibility and make room in my life for all the other things that I am excited about.
Why Did I Do It?
It’s the right thing to do.
Most of all, it reflects my view of reality more truly. The cash I put into this business to help it take off has certainly played a part in building it, but this has been far outweighed by the dedication and care from the team.
It feels great.
I love paying the distributions to the whole team. It is a way of showing my appreciation for what they are doing.
I can afford it.
I am well looked after in this transaction. There is no need for me to suck every last drop of value out of this.
The team is more committed?
That is what the textbooks say, but I don’t think this is true. The team was just as committed before. In addition, I don’t believe in golden handcuffs at all and actively hope that we have not created a situation where someone would like to leave and does not do it due to a fear of losing out on the ownership.
I want to inspire others.
I would love to hear from other business owners who think this could be something you want to do as well.