How employees get their money back

The underlying problem

In a listed company, an employee shareholder sells their shares in three clicks. In an unlisted SME, there is no market. Their shares are worth only what someone agrees to pay, on the day someone agrees to buy.

The consequences show quickly. A manager who leaves the company after six years ends up with shares they can neither sell nor value. They hold on to them reluctantly, become an outside shareholder little inclined to approve decisions, and their situation discourages the remaining employees from joining the capital.

This scenario is not rare. It is the most common failure mode of employee ownership plans in SMEs, and it plays out entirely in clauses that should have been written at the outset.

Who buys back the shares

Four configurations exist, and they are often combined.

The company buys back its own shares. Technically possible under conditions, with a capital reduction or temporary holding depending on the case, within the framework set by the Commercial Code. It is the simplest solution for the employee to understand. It weighs on the company's cash at precisely the moment it is often needed elsewhere.

The owner-manager or the historic shareholders buy back. Effective, provided they have the personal cash required and are still present. This solution ages badly if the owner-manager sells up in the meantime.

The other employee shareholders buy back. Consistent with the spirit of the scheme and hard to implement in practice, because employees rarely have the cash at the moment the seller needs it.

An investor provides the liquidity. A long-term minority shareholder undertakes to buy back leavers' shares according to a known formula. This is the role we play in the transactions we finance, because it relieves the owner-manager and the company of the burden of funding exits.

When the window opens

Permanent liquidity does not exist in an SME. It therefore has to be organised at intervals.

The most common mechanism is the annual window. Once a year, after the accounts are approved, a period of four to six weeks opens during which employee shareholders can request the buyback of all or part of their shares. The price is the one produced by the formula applied to the accounts of the closed financial year.

This window is combined with automatic exit events: leaving the company, retirement, disability, death. It can also carry an overall cap, in the order of a few per cent of the capital per year, to prevent a collective movement from putting the company in difficulty.

Some companies provide for an initial lock-up period of three to five years. That is consistent with the retention objective, provided it is announced clearly from day one.

At what price, and why the formula must be written beforehand

This is the heart of the matter. Three approaches coexist.

The automatic formula. An EBITDA multiple defined in the shareholders' agreement, applied to the average of the last two or three financial years, adjusted for net debt. It is predictable, hard to dispute and easy to understand. The risk is rigidity: a formula written in 2019 can become absurd after a change in the sector's context.

The independent appraisal. An expert values the company at each window. It is fairer in substance and more expensive, with an additional delay. In the event of disagreement, article 1843-4 of the Civil Code also allows an expert to be appointed. This approach suits companies whose activity varies strongly.

The formula framed by a collar. An automatic formula, with a floor and a cap, and the option of calling on an expert in exceptional circumstances defined in the shareholders' agreement. This is the compromise we recommend most often.

In every case, the absolute rule is the same: the method is written before the first allocation. A valuation negotiated at the time of an employee's departure almost always turns into a conflict, because both parties have a direct and opposing interest in the outcome.

Departure, misconduct, death: the clauses you have to dare to write

Shareholders' agreements generally distinguish several exit situations, with different consequences for the price.

A resignation after a long tenure, retirement, disability or death are so-called good-leaver exits, valued at the full formula price. Dismissal for gross misconduct or a resignation in the very first years may give rise to a discount, or even a buyback at the acquisition price.

These clauses are unpleasant to draft and indispensable to have. Without them, an employee who left in a conflict keeps a shareholder position in the company they have left. With them, the rule is known to everyone from the start and nobody discovers the conditions at the worst moment.

A simple principle guides their drafting: they must be explainable out loud, in a meeting, in front of the people concerned, without the owner-manager having to look down. A clause you do not dare to present is a clause that will produce litigation.

That leaves the financing. A liquidity mechanism without financing is an empty promise. Three practical solutions: a provisioned buyback fund, topped up each year by an estimated percentage of exits; a staged payment over two or three annual instalments, possibly with interest; or an investor who carries the liquidity within a defined annual limit.