How do you buy into a business as an employee?

An architect had reached the maximum level of salary he could reach as an employee and was offered the opportunity to buy shares in the practice he worked in.

He was very keen, but his wife was concerned that the level of buy-in required would mean they had to re-mortgage their house.  She asked him to enquire about other options.

For both the employer and the employee buying into the business, one of the most important considerations is how you will structure any purchasing arrangements between the employee and the practice.

How this occurs will depend on the financial situation of the company or partnership and the employee themselves.

The traditional approach is for the employee to pay cash for the shares or interests from their own savings. However, in the current economic climate, with many employees having high levels of student and other debt, this is becoming less and less likely.

Therefore, many practices are having to rethink options for financing a purchase.

A common option is for the business to provide a ‘loan’ to the employee, which is paid back by dividends in the case of a company, or drawings in the case of a partnership. 

There may be a defined time frame within which the loan is to be repaid, which may depend on the profitability of the business.  From the business’ perspective, this loan could come from their own capital, or by borrowing from a bank itself (and charging the interest to the employee as part of the arrangements).

Another option is for the employee to borrow the funds from a bank.  This may require the company or partnership to guarantee the lending.  The cash provided from the loan is then paid to the outgoing shareholder (if buying from one person), or to all partners or shareholders if a new set of shares or partnership interests is being created.

It may also be that an employee buys shares or interests gradually through a staged purchase often with progressive levels of responsibility and/or voting rights given to the employee throughout the  various stages of buy in.   This is becoming more common.  

In this scenario, the employee would purchase a small shareholding funded in cash and be entitled to receive dividends in proportion to that shareholding.  The shareholder may receive no voting rights in the company initially, or different voting rights to other shareholders.

However, once they met certain KPI’s and milestones, the purchase can then be progressed to the next stage, when they would purchase additional shares, be appointed as a director, and be given full voting rights on par with the initial shareholders.

The transitional stage would therefore create different classes of shares with different voting rights and this would be documented in the shareholders agreement.

The loan from the business or the staged purchase may mean for the architect above that he did not need to consider re-mortgaging, or further borrowing against, his family home.

It is important to take both legal and accounting advice if you are an employee buying into a business that you work in, to make sure it is structured appropriately for both parties.

Leading law firms committed to helping clients cost-effectively will have a range of fixed-price Initial Consultations to suit most people’s needs in quickly learning what their options are.  At Rainey Collins we have an experienced team who can answer your questions and put you on the right track.

Claire Tyler and Charlotte Cameron