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Employee Ownership: Overcoming Common Challenges for Success in Your Business

Employee Ownership

Employee Ownership: Overcoming Common Challenges for Success in Your Business

By , April 4, 2024
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Employee Ownership Plans (ESOPs) provide a unique opportunity to transform the dynamics within a company, fostering a sense of ownership and alignment with business goals. The benefits of employee ownership are well documented across cultural, financial and longevity factors.

Ownership culture reinforces employee commitment and a sense of job security. This distinctive outlook not only makes staff more effective in their roles but also amplifies company success. Shared ownership and collective responsibility can boost both individual job performance and raise the performance of their co-workers.

Business owners can greatly benefit from employees adopting the ‘ownership mindset’, and ESOPs offer numerous advantages for employees, from financial rewards to enhanced company culture:

  1. Financial Rewards Ownership in the company translates into financial benefits for employees, distributing wealth through dividends, profit-sharing, or stock options.
  2. Increased Certainty Employee ownership enhances stability and visibility at work, increasing job security and aligning employees even through the peaks and troughs of economic cycles.
  3. Greater Employee Engagement Employee ownership fosters higher levels of employee engagement, increased productivity, innovation, and a positive work atmosphere.
  4. Improved Company Culture Employee ownership encourages a sense of shared responsibility and accountability, promoting an ethical and responsible company culture.
  5. Opportunity for Leadership Employee ownership provides opportunities for leadership development, as employees invested in the company’s success are more likely to advance in their careers and take on leadership roles.

However, just because something is good for us doesn’t mean people will embrace it. Ask any dentist how many of their patients floss daily — if at all!

Employee-owned firms come with their own set of challenges. And, while any business transformation carries risks, though these can be largely avoided with careful planning. So, before you dive headlong into employee ownership implementation, let’s explore the common challenges businesses face when and provide strategies to successfully overcome them.

Challenges in Implementing Employee Ownership Plans

As companies increasingly explore the benefits of granting employees a stake in the enterprise, it’s common to encounter hurdles ranging from communication gaps and resistance to change to the intricacies of structuring equitable ownership arrangements.

Whether you set up an Employee Ownership Trust, an Employee Share Scheme, or an Employee Stock Option Plan, or ESOP, challenges can all be overcome with planning and expertise to create a framework that fosters employee engagement and sustainable growth.

Challenge 1: Selecting Your Employee Ownership Model

You’re at the crossroads here, with four pathways to consider for employee ownership: Employee Ownership Trusts (EOT), Employee Share Ownership Plans (ESOP), Employee Share Schemes (ESS), and worker cooperatives.

  1. Employee Ownership Trust (EOT): An EOT is a legal trust structure and financial instrument that enables employees to collectively own and benefit from the shares of a company.
  2. Employee Share Ownership Plan (ESOP): In an ESOP, employees are granted shares or offered the opportunity to purchase company shares (also known as ‘options’) at a pre-determined price.
  3. Employee Share Scheme (ESS): In Australia, an ESS allows companies to offer ordinary shares or options to employees as part of their remuneration.
  4. Worker Cooperatives: Worker cooperatives are business entities owned and democratically governed by their employees, where each worker has a stake in decision-making and financial benefits are shared collectively among the workforce.

Solution: Get a free consultation with a Succession Plus Partner to discuss what you’re trying to achieve through employee ownership and get a recommendation to suit your current business situation.

If you have any reservations or uncertainty, this is a no-obligation opportunity to get clearer on whether employee ownership is right for you — and if it is, what next steps you’ll need to take.

Challenge 2: Communication and Education

Effectively conveying complex financial concepts and the nuances of employee ownership can be challenging.

Misunderstandings can lead to uncertainty or resistance among employees. Maintaining consistent and transparent communication throughout the ESOP’s lifecycle is crucial, yet it may be challenging to provide ongoing updates and address concerns.

Additionally, educating employees about the implications of their ownership and the impact on day-to-day operations demands ongoing effort.

Solution: Businesses must invest in clear, ongoing communication and education about Employee Ownership, beginning with the basics of how it works and how it aligns with the company’s vision.

The leadership team, supported by your Succession Plus partner, will be responsible for updating employees on the progress and value of the ESOP and arranging educational resources to help employees understand their role in the ownership structure.

What constitutes ‘good communication’ will differ between industries and businesses. Many of our clients take a light-touch approach at the beginning and steadily increase buy-in as more employees hear about the first-hand benefits from their early adopter peers.

However, Succession Plus has several proven techniques to help solidify the way forward with ESOP.

We arrange an employee stock options presentation to all eligible staff in partnership with an ESOP consultant and professional counsel (lawyer and accountant) to help them understand the mechanism and its benefits.

Eligible employees will be provided with a written guide to the ESOP. Where it’s not possible to have all employees in the room, we can also record the presentation for future reference.

Employees considering joining the ESOP are encouraged to direct their questions to your Succession Plus Partner, alleviating the time burden from the business — and ensuring that they get accurate information.

Your business may wish to display an internally-directed ‘stock ticker’ for their ESOP total value and individual share value, placed on the company intranet home page. While not as sophisticated as a live-updated ASX ticker, quarterly accounting can be used to indicate growth or retraction of the shares’ value.

Challenge 3: Funding the ESOP

Securing the necessary funds to establish an ESOP can be a hurdle for some businesses.

Initially, companies need to secure the capital to purchase existing shares or new shares for the plan. This can strain cash flow and may require external financing.

Additionally, the ongoing funding for ESOPs involves contributions to the trust to buy out departing employees’ shares, leading to potential liquidity challenges.

Companies may face difficulties in balancing the need for sufficient capital investment in the business while meeting the financial obligations of the ESOP.

Solution: Options include borrowing externally through bank loans, using generous tax concessions to assist employees in acquiring shares or using a profit share-based model to fund the plan over time. More than 90% of Succession clients utilise this aspect as part of their plan.

Depending on the way your scheme is structured, employees may be able to participate using a salary sacrifice model — which for some can be tax-positive.

Additionally, certain companies offer rights or options at the employee level as alternative methods for facilitating share ownership. Each approach presents distinct financial mechanisms for employees to participate in the ownership structure of the company.

It’s essential to work closely with financial experts to determine the most suitable financing strategy based on the company’s financial health, business goals and plan timelines.

Challenge 4: Valuation and Fairness

Determining the fair market value of a company’s shares is a complex process that often requires external appraisers and financial experts.

Challenges may arise in accurately assessing the company’s worth, particularly for niche private businesses with limited market comparisons.

Ensuring fairness in the distribution of shares among employees can be challenging as well, with potential concerns about equity and transparency.

Solution: There are many methods for determining a company valuation. Whichever is recommended, the important thing is that it’s transparent to all involved about the company’s financial state.

  1. Engage Qualified Professionals: Seek the expertise of certified valuation professionals, such as Certified Valuation Analysts (CVA) or Chartered Financial Analysts (CFA), who can provide an unbiased and accurate assessment of the company’s value.
  2. Define the Purpose of Valuation: Clearly articulate that the purpose of the valuation is for an ESOP rather than a potential sale, merger, acquisition, financial reporting, or strategic planning.
  3. Gather Comprehensive Financial Data: Collect extensive financial information, including historical and current financial statements, cash flow projections, and other relevant financial metrics.
  4. Choose Appropriate Valuation Method: Select the most suitable valuation methods for the company’s industry, size, and financial characteristics. Common approaches include the income approach, market approach, and asset-based approach.
  5. Consider Industry and Market Trends: Analyse industry trends, market conditions, and economic factors that might impact the company’s valuation and position in the market.
  6. Assess Risk Factors: Evaluate risk factors associated with the company, such as market volatility, industry competition, and internal risks that may not be financial but have financial implications.
  7. Benchmark Analysis: Benchmark analyses compare the company to similar businesses in terms of size, industry, and market presence — providing a benchmark for relative value. Succession Plus has some of the best benchmarking tools built into our Capitaliz platform, designed to help compare mid-market private businesses for valuation purposes.
  8. Consider Future Growth Prospects: Growth projections and potential opportunities in the market landscape can help support the buy-in of an ESOP. However, as with any investment, these elements must be acknowledged as ‘forward-looking statements’ rather than guarantees of future value.
  9. Document the Valuation Report: Prepare a detailed valuation report documenting the methodologies used, assumptions made, and key findings. A well-documented report ensures transparency and provides a reference for stakeholders in your ESOP.
  10. Regularly Update Valuation: Given the dynamic nature of business, it’s worth arranging periodic valuations of the employee-owned company. The software platform Capitaliz, developed by Succession Plus, provides Dynamic Revaluation™ that adjusts valuations based on financial and non-financial factors, as well as macro market fluctuations.

Challenge 5: Managing Employee Expectations

Some employees have likely grown accustomed to the chain of command, and an ESOP might lead them to worry about who’s in charge. Others might be a little too eager for a chance to steer the ship. It’s possible that both groups will imagine shorter-than-realistic timeframes into meaningful equity.

Lastly, the expectations of financial windfalls and promotions at work can lead those not involved in the ESOP to become bitter or resentful.

Solution: Clearly define the scope of employee ownership and the extent of decision-making power. Ensure employees understand that while they have a stake in the company’s success, certain strategic decisions may still be made by leadership.

It also had to be clear that an ESOP is far from a ‘get rich quick’ scheme — that benefits unfold over time, and the value is tied to the company’s performance.

Succession Plus will detail the mechanisms for employees to provide input and feedback, promoting a collaborative atmosphere.

Challenge 6: Leadership Transition

Transitioning leadership within an ESOP can be a sensitive process. Any change in leadership may trigger concerns about the continuity of the company’s vision and strategic decisions, potentially causing apprehension among employee-owners.

The intricacies of balancing individual leadership styles with the collective nature of employee ownership can also pose challenges, impacting the overall dynamics of the leadership transition within the ESOP structure.

Solution: Identify and groom potential leaders early, providing them leadership development and mentorship opportunities. Develop a clear leadership transition plan that outlines roles and responsibilities, ensuring a smooth shift in leadership when the time comes.

Challenge 7: Measuring and Communicating Success

Measuring success in the context of an Employee Stock Ownership Plan (ESOP) brings forth its own set of challenges.

Firstly, quantifying the impact of employee ownership on the company’s performance can be intricate, involving various financial and non-financial metrics.

Secondly, determining the effectiveness of the ESOP in enhancing employee engagement and satisfaction may face challenges due to subjective interpretations.

Solution: Establish key performance indicators (KPIs) that align with the company’s goals and the ESOP’s objectives. Regularly measure and report on these KPIs, demonstrating the tangible benefits of employee ownership. Share success stories and case studies that showcase how employee ownership positively impacts the business.

Challenge 8: Sustaining Employee Engagement

Employee engagement in an ESOP can wane over time if not actively nurtured. Another challenge lies in addressing the diverse needs and preferences of a multi-generational workforce, as engagement strategies may not have a one-size-fits-all solution.

Some may see Employee Ownership as a pathway to retirement and maintain a high level of interest. Others may find that ‘work gets in the way’ of creating the kind of change they’d hoped for especially as the novelty of employee ownership naturally wears off over time.

Solution: Regular staff updates are vital to the success of your ESOP or ESS.

You might consider email updates to the whole team (including those not engaged in the plan yet), quarterly shareholder meetings, creating a dedicated ESOP channel on Slack, and advertising specific opportunities for employee shareholders to participate in decision-making.

Challenge 9: Compliance and Regulatory Requirements

In Australia, businesses implementing an Employee Stock Ownership Plan (ESOP) or Employee Share Scheme (ESS) must adhere to specific legal and regulatory requirements. Some key considerations include:

  1. Corporations Act 2001: The Corporations Act sets out the legal framework for companies in Australia. Businesses establishing an ESOP or ESS must comply with provisions related to the issuance of shares, disclosure requirements, and corporate governance.
  2. Employee Share Scheme (ESS) Rules: The ESS rules provide specific guidelines for the tax treatment of employee share schemes. This includes rules related to the taxation of benefits arising from employee share schemes, reporting obligations, and the eligibility criteria for concessional tax treatment.
  3. Australian Securities and Investments Commission (ASIC): ASIC oversees the regulation of companies in Australia. Businesses need to comply with ASIC regulations regarding the registration of prospectuses, disclosure requirements, and other corporate compliance matters.
  4. Taxation Laws: Compliance with Australian taxation laws is crucial for businesses implementing ESOPs or ESSs. This includes understanding the taxation treatment of employee shares, reporting requirements, and ensuring that schemes meet the criteria for favourable tax treatment.
  5. Fair Work Act 2009: Businesses need to consider the provisions of the Fair Work Act, which governs various aspects of employment relationships in Australia. Compliance with employment laws is essential to avoid disputes and ensure fair treatment of employees participating in share schemes.
  6. Australian Prudential Regulation Authority (APRA): If the ESOP involves the issue of securities that are regulated by APRA, such as certain employee share schemes in the financial sector, additional regulatory requirements may apply.
  7. Competition and Consumer Act 2010: Compliance with competition and consumer laws is crucial, especially if the ESOP involves restrictive trade practices or has implications for market competition.
  8. Australian Accounting Standards: Businesses need to adhere to relevant accounting standards when accounting for employee share-based payments. This includes accurately reporting the value of share-based payments in financial statements.
  9. Continuous Disclosure Obligations: Listed companies must comply with continuous disclosure obligations, ensuring that material information related to the company’s performance or other factors is promptly disclosed to the market.

Solution: Seek legal counsel and stay informed about compliance obligations by working with an Employee Ownership professional such as Succession Plus.

We’ll help you regularly review and update the ESOP plan to ensure it remains compliant with evolving regulations and as your business changes. You may find it beneficial to manage the plan using an ESOP portal or app for administration reporting and employee communications.

Thriving Through Employee Ownership

While implementing employee ownership may present challenges, businesses that navigate these obstacles successfully can reap the rewards of a more engaged and motivated workforce, increased profitability, and a lasting legacy of shared ownership.

By addressing communication, funding, valuation, leadership transition, and employee engagement proactively, companies can build a strong foundation for employee ownership and unlock its full potential for success. Remember, the journey may be challenging, but the destination is a thriving and united workforce that drives business growth and prosperity.

 

Craig West

Craig West

Executive Chairman | Succession Plus

Craig West is a strategic accountant with over 20 years of experience advising business owners. His background as a CPA in public practice has provided invaluable experience in the key issues of concern to business owners.

In March 2014, Craig was appointed Executive Chairman of the SME Association of Australia, Australia’s largest small business organisation representing over 300,000 business owners.

In October 2014, he was awarded the Exit Planner of the Year at the Exit Planning Institute Annual Conference in Texas, USA, due to his innovative development of an exit planning process to help business owners maximise business value and achieve a successful exit.

Craig’s proprietary structure - a Peak Performance Trust - has won the Australia-wide award for the Employee Share Ownership Plan of the year twice in four years.

In November 2018, Craig launched SME Experts in partnership with Mark Bouris’ Mentored on Podcast One and quickly grew the monthly podcast audience to over 26,500 downloads; in October 2019, he released a new podcast focused on medium-sized businesses - Mid-Market Matters.

In July 2021, Craig joined the NSW Committee for STEP (Society of Trust & Estate Practitioners) – focusing on advising families across generations.

Craig has also launched a SaaS platform, Capitaliz (which captures the 21-step process), to assist other advisers internationally deliver advisory services at scale.

In November 2021, Craig was appointed Executive Chairman of NSW Leaders, a business mentoring group for leading NSW businesses.

In July 2022, Craig West received the award of Doctor of Business Administration for his research thesis titled “Examination of the key factors driving business exit options in Australian Small and Medium Enterprises.”

Craig is passionate about encouraging business owners to think strategically, maximise the value of their business and achieve a successful exit.

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