Employee owned businesses: access to funding

The aim of the research was to examine access to funding for employee-owned businesses (EOBs) in Scotland, of which there has been a significant increase in the last few years; it is estimated that the UK employee owned sector is now worth £25 billion annually, representing around 2% of GDP. The research had two main objectives: to consider the role of funding for firms moving into employee ownership, and whether this inhibits or constrains firms becoming employee-owned; and to examine the issue of funding as a constraint on growth for existing EOBs and to judge whether lending institutions view these firms as ‘atypical’ companies.

The methodology consisted of a literature review of studies on funding, succession and employee-owned businesses, and interviews with two groups of companies: current EOBs; and firms considering, or who have considered, some form of employee ownership. Intermediaries, including banks and corporate lawyers were also interviewed. Secondary research was conducted to assess EOBs in the wider economic context. This included analysis of relevant business statistics to assess potential future succession businesses and an estimated market sizing for EOBs.

The research found that the majority of firms had required capital in the £1-5million range to undertake the transition to employee ownership, in order to purchase equity from the original owners. The predominant method of funding the transition was found to be vendor finance through retained earnings, with banks generally playing a relatively small role. A number of issues for firms considering employee ownership were identified, in terms of the nature of the entrepreneur’s exit decision. These included the speed at which entrepreneurs wished to exit; a strong preference for not using bank finance; a preference for financing using company retained earnings; and limited ability of employees to provide investment,. For provision of working capital it was found that the majority of EOBs relied on retained earnings, supplemented by bank overdrafts, personal loans and other loans when absolutely necessary. Reinvestment of retained earnings was found to be the predominant approach to growth funding.. It was also noted that the majority of EOBs did not report any plans to raise any finance in the next two years, and that bringing in outside equity was not seen as a desirable option, even if there were implications for growth. Attitudes towards bank lending were found to be mixed, although it was suggested that there was a general reluctance to borrow, even though only two of the EOBs had been turned down by a lending institution in the last five years. Findings from the interviews with intermediaries suggested that while most of the banks had had few dealings in the past with EOBs, banks and other external lenders treated all businesses equally irrespective of their ownership structures. Overall, the research concluded that for most EOBs, a significant funding gap does not exist.

The research suggested two areas in which policy could potentially be re-formulated: focus and targeting; and the thematic nature of support. It was suggested that there could be value in a stronger level of policy focus aimed towards three different groups: entrepreneurs close to retirement age; employees working in firms considering employee ownership; and key industrial sectors which have strong synergies with this form of ownership structure. The research indicated that by improving targeting toward these groups, there may be more success in promoting employee ownership across the Scottish economy. It is also suggested that it may be valuable to stimulate the demand within SMEs for external lending, in order to help overcome the problem of ‘reluctant borrowers’. A peer-to-peer lending fund provided by state bodies, as opposed to a government loan fund, is recommended as a preferable policy intervention, as a lower risk option.