In advance of the third and final webinar in the Employee Ownership Explained series, we caught up with guest speaker, Linzi Wilson from Consilium Chartered Accountants, for a few pointers to help business owners considering an EOT make an informed decision.
Linzi Wilson is Corporate Finance Partner at Consilium Chartered Accountants. Linzi qualified in 2005 and has over 17 years’ experience in the Corporate Finance sector working with a range of clients, large and small, across a diverse range of industries. Linzi specialises in business sales, financial modelling, raising finance, and sourcing grant funding.
There has been a significant increase in interest in the Employee Ownership Trust (EOT) as a succession option in recent years. Although it’s an exit route that won’t suit every company, it is certainly worth exploring for many.
At Consilium Chartered Accountants, we advise on EOT transactions for businesses across a broad range of Scottish industries and sectors. For business owners considering an EOT, there are a few pointers we can share to help them make an informed decision.
Preparing for an Employee Ownership Trust transaction
The first step often involves a little tidying up. Some companies have unusually complicated structures that have evolved over time and no longer reflect the purpose of the business. An experienced firm of chartered accountants can suggest ways to structure the company for a smoother transaction.
Secondly, financial matters may also require attention. For example, are there satisfied charges on the company that show as unsatisfied? Do the company books accurately reflect the current shareholding? Investing some time in getting everything in order makes the process easier going forward.
Is an Employee Ownership Trust the right option for your business?
Before embarking on any transaction, as advisors we would want to gain a clear picture of what the business owner hopes to achieve. Increasingly, Consilium clients are exploring an EOT as a business disposal option. Our role as advisers is to ensure they are making informed decisions and that an EOT is the best solution.
The process begins by exploring what the current owner’s aspirations are, both financial and personal. From a business perspective there are some fundamental questions to be asked: is the business in a robust position with a positive outlook? Is there a management team ready to step in when the owner looks to exit?
One of the beauties of the EOT legislation is that it is flexible. The EOT can coexist with management or employee share schemes, equity sharing, or other incentives. An experienced firm of chartered accountants can help guide you through what might work best for your business.
Once it is clear that a sale to an EOT is the appropriate way forward, an advisory firm like Consilium will determine a valuation that the seller is happy with and makes sense for the company. Almost all EOT transactions are funded by the company, and a rigorous assessment is required to ensure that the price is affordable.
Valuing a company for an EOT: key considerations and adjustments
I’m often asked how you value a company for an EOT transaction. In a nutshell, it’s a calculation based on future maintainable profits – how much value can this business generate? There are various items we have to consider as part of this exercise: when are the owners planning to exit? Are adjustments required for salaries if dividends will no longer be available for remuneration? What working capital will the business need?
As the company is usually the funder for these transactions, this can be done directly from the profits and sometimes by bringing in an external lender. Any surplus cash in the company can be paid to the seller on day one, taking care to leave sufficient working capital in the business for it to continue to function effectively and deal with any unexpected costs that arise. The remainder of the purchase price will be paid using deferred consideration.
Deferred consideration requires a repayment plan that fits with the company’s cash flow forecasts. Typically, this plan would be for a period of 5-7 years but can be more or less than that. It’s important the business isn’t stretched by an over-ambitious repayment schedule.
Advisers must consider the impact on the company; will a long timescale feel like a never-ending burden to the new management and mean financial benefits are a long way off for the employees? All companies differ in their cash needs and an appropriate solution will support the company’s success rather than compromise it. Repayment plans can also be structured to allow the company’s directors to “overpay” when the company finds it has more cash available than budgeted.
Part-financing an Employee Ownership Trust through lending
Increased interest in EOTs has been the catalyst for an expansion in the number of lenders keen to finance such transactions, usually in part. Consilium will propose bringing in external finance as a way for the seller to realise the bulk of their value more quickly, if appropriate.
It is usual that the loan is to the trading company and the lender may require some guarantees and securities on any lending. It’s always worth exploring whether bringing in an external lender might be a useful addition to the transaction.
Employee Ownership Trusts and HMRC tax clearances
One of the key tasks of the EOT transaction that usually falls to the accountant is the application for tax clearance to HMRC. Consilium always recommends this is sought in advance of the transaction completion.
HMRC wants to be satisfied that the transaction is taking place for bona fide reasons; the purpose is to create a business that is owned long-term by the employees, not as a tax avoidance measure. The clearance usually contains the seller’s motivations for pursuing this path, a description of the transaction, and the methodology for calculating the valuation. At Consilium, we are yet to have any queries on applications to HMRC for EOT purposes, but I do hear from other advisers that HMRC is scrutinising these more closely.
Creating positive outcomes for business owners and employees
From a personal perspective, EOTs are a particularly enjoyable transaction to be part of. We have the unique opportunity to support our clients in what might be the biggest decision of their business lives. Secondly, these projects tend to be more collaborative and there is great satisfaction in creating positive outcomes for the current owner and a lasting legacy for those who have helped build up the business. Furthermore, clients typically retain Consilium after a successful EOT affording us the opportunity to help them realise new ambitions.