Employee Ownership Explained – The Role of the Legal Adviser in the EOT Transaction

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The latest webinar in the Employee Ownership Explained series took place on Wednesday 21 September. This month, the focus was on the role of the legal adviser in employee ownership transactions. Having worked on a number of these transactions himself, Bruce Farquhar of Anderson Strathern gave an insightful overview of the process from a legal adviser’s perspective.

The presentation began with a useful summary of the tax advantages that employee ownership trusts offer and an explanation of the structure of an employee ownership governance model. This was particularly useful as the majority of attendees did not have direct experience of implementing an employee ownership trust.

Bruce then went on to discuss the key aspects of an employee ownership transaction. He highlighted that there are some essential decisions that need to be made, including:

  • the share price;
  • the number of shares being sold;
  • how the transaction will be funded;
  • the timing of the payment of the purchase price; and
  • the choice of trustee.

Once these matters have been decided the key legal documents can be drafted. Typically, this will include a share purchase agreement, a trust deed and new articles of association for the company. Final drafts of the documents should be submitted to HMRC for tax clearance prior to completion. The whole process usually takes around 3 months.

Bruce emphasised that it is important that the founders of the business are involved from the outset and that good lines of communication are established between advisers. He also highlighted that in employee ownership transactions all interests are aligned. From a professional adviser perspective, this offers a different rhythm and balance to standard M&A transactions.

The presentation was followed by an interactive Q&A session, a summary of which is outlined below.

A poll carried out during the webinar highlighted that 52% of attendees felt that a lack of awareness was the main thing stopping business owners from considering an employee ownership transaction as an exit route. Following the session, however, the majority of advisors who attended said that they would be likely or very likely to discuss a sale to an employee ownership trust with a client considering succession.

A recording of the webinar can be found here:

A copy of Bruce Farquhar’s presentation is available here: The Role of the Legal Adviser in the EOT Transaction

Questions & Answers

Very few business owners present. Is this a concern?
This stream of webinars is aimed at professional advisers with the objective of supporting them in presenting the EOT option to their clients.  The lack of knowledge of employee ownership was one of the key barriers identified in the Nuttall Review. In response to this, CDS launched an initiative to support advisers in finding out more about this.  This initiative has been running for 6 years now with encouraging results.

Are there common messages to ensure that employees’ ownership is more than just a financial ownership?  For example, do they get involved in appointing Trustees to the Employee Ownership Trust?
Yes, it would be usual for employees to elect Trustees, and it would be usual to have employees as trustees. It is also the case that some companies opt to elect employees to serve as directors on the trading company board. The employee ownership structure is very flexible and what matters is that the model fits the business. It is imperative that any directors should receive full training prior to taking up these positions.

How many Employee Ownership Transactions fail to complete once they have formally started?  I would imagine with the collaborative nature of the transaction it would be a lot fewer than traditional sales routes?
Correct. Very few of these transactions do not complete. There can be a long incubation period while the owner considers their options, and the CDS Feasibility Report helps with that decision-making process. Sometimes business gets in the way and can delay the transaction. It is very rare that these deals do not reach a successful conclusion.

Is there any support for companies in terms of financial help with the cost of advisers? It sounds as if there is a lot of advice required and could be costly.
CDS can offer an Ownership Succession Review which will explore all the exit options and should employee ownership be judged viable, CDS can provide a free Feasibility Report to companies looking to find out more.  This feasibility report also gives some indication of what the costs of the transaction would be.

How do you see the taking of security over deferred consideration working in the context of maintaining compliance with the controlling interest requirement?
It is clear that the Trust can’t give a charge over the shares that it owns in the trading company for the deferred consideration element. In the transactions which we have worked on, no securities have been taken over the company’s assets by the founder, perhaps because of the founder’s confidence and their continuing role in the business.

It was mentioned that due diligence is usually “light touch”.  As a Trustee would you not want a more robust due diligence process undertaken in the event you might be taking on an undiagnosed issue?
The Trustees are effectively acquiring a controlling interest and paying a considerable sum of money and they have to be satisfied the valuation is correct and there are no potential material issues that will impact that. In reality, the stakeholders in the transaction are inextricably linked with the business and know what the issues are.

25% is the threshold at which an employee can be called employee-owned.  Do you see examples where the employee stake is higher than this and is it usual for more shares to move to the EOT?
It is now usual for more than 50% of shares to be placed in the Trust to enable the company and the sellers to benefit from the tax incentives. It can get complicated when there is a mix of direct shareholding by employees and indirect shareholding by Trust.

Have we seen any professional firms, in particular accountancy practices move to employee ownership?
There are a few examples of professional firms who have adopted employee-owned models.  We are not aware of any in Scotland and that may well be due to the regulatory requirements of the relevant professional governing bodies.

Do the owners have to work until the full amount has been paid to them?
No, the owners can choose how long and in what capacity they remain with the business and this position is usually protected while there is money outstanding to them.

The CDS team is happy to provide information and signposting to companies and their advisers who may wish to find out more.

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