Finance

In an employee buy-out, cash is needed to pay the outside owners, to buy their shares. The aim is to end up with no outside shareholders – so that the company is owned entirely by [or on behalf of] the employees.

A trust - acting on behalf of employees – is a valuable mechanism for making an employee purchase possible. It gives employees a vehicle to use the company's own resources and/or a loan to finance the purchase. Without this kind of finance, or beneficial terms from the vendor, employees would have to finance the whole purchase out of their own personal resources.

Where does the money usually come from to buy the company's shares? In order of attractiveness, given normal financing terms, the five main options are:

• Extra cash within the company – this simply means additional disposable funds that it's safe to use to finance all or part of the purchase price.
• Employee savings or shares – if most or all of the employees are prepared to invest their own savings, that can be a good source of finance. However, it's essential that employees realize their cash will be tied up for an indefinite period of time, and that they may lose it. Investing personal money can be a risky thing to do.
• Vendor finance – this just means that the owners selling their shares take their cash over time. In This type of finance can be relatively easy to arrange because the vendor knows the company, is used to taking whatever risks are involved, and is well motivated towards the company. Also, some vendors may reduce their sale price for philanthropic reasons - it's always worth asking!
• Borrowings – borrowing from a bank can finance part of a purchase price, depending on the relationship between the company and the bank, but never all of it. The bank will usually require a great deal of reassurance that it's not taking an unusual risk. Normally the bank will take security over company assets, and will require priority for its money over any other provider of funds. The main advantage to the company is that the interest rate for this part of the debt should be relatively low.
• Mezzanine finance – this is finance that accepts a greater level of risk than the bank, and so demands a higher rate of return. The interest or dividend rate will be more expensive than the bank debt, and the timing of the repayment will be subject to agreement with the bank - the bank will always take priority.

More on finance

If the company is going to maintain its independence and employee ownership long term, it's important that it does not sell ordinary equity to outsiders. Even if the mezzanine finance seems expensive, it has the advantage of being contractually limited and so it can be paid off - it does not give the provider ownership rights over the company, in the way that ordinary shares do. This is extremely valuable.

At the same time, it is important that the terms of the mezzanine finance should not be onerous - for example, there should not normally be a participation in profits, and care must be taken over any provisions that give the holder more rights if financial targets are missed.

• Baxi Partnership [a Member of the Employee Ownership Association] can provide finance using a range of financial instruments from debt to equity for buy outs where the company is strong and successful business with an experienced and capable management team
• Funders Co-operative and Community Finance can provide unsecured loans of up to £50,000.