Updated: Apr 19
Preparing for employee ownership
Businesses that are suited to employee ownership are generally mature with profit levels that are able to repay the funding required for the transaction within a realistic payback period.
Employee Ownership Trusts use future profits to pay back funding and relative valuations are often based on multiples of profit. Asset heavy businesses with higher profit margins are able to secure funding and repay debt faster.
Understanding How Profit Adjustment Impacts Value
Prior to estimating value, a more accurate measure of profitability needs to be established and EBITDA (Earnings before interest, tax, depreciation and amortisation) is used as a starting point. The EBITDA margin is then adjusted to reflect changes when the business transfers to employee ownership.
When a business changes hands some of the costs generated by the departing shareholders will no longer be required enhancing profits. Conversely, some of the contributions made to the business by the departing shareholders may need replacing, such as the cost of new management for example. These adjustments to the EBITDA margin, are called add-backs and add-forwards and when applied, reflect a more accurate measure of the profitability of the business moving forward.
The adjusted *EBITDA can now be used in different valuation methods. Applying profit multiples from similar transactions in your sector to your adjusted EBITDA will provide a ballpark indication of your enterprise value. Further adjustments need to be made for debt, surplus cash and working capital required by the business moving forwards.
It’s important to understand that any increase in profitability prior to transition could be worth several times that amount when the company is valued. In the same way, any direct or indirect cost savings achieved prior to transition could be worth several times the amount saved, when the company changes hands.
Comprehending which expenses can or cannot be added-back to EBITDA and how profitability impacts future deal value enables shareholders to achieve an accurate valuation when the business transfers to employee ownership.
Improving profitability prior to transition to employee ownership, not only enhances value for the shareholders but preserves your legacy by transferring a healthy and promising business to your management and staff. Enhanced profits and free cashflow will enable the future repayment of the sale price and provide staff with the necessary financial incentives to improve efficiency and productivity.
If the financial health of the business cannot support shareholder value aspirations, then our services can be paused until the financial position is improved.
Call us on 01384 274 778 / 075 888 925 88 to discuss or go ahead and book a free consultation to explore your options.