The sec
ond Employee Ownership Explained webinar in the series took place featuring legal experts Douglas Roberts and Nimarta Cheema of TLT LLP.
The full webinar presentation can be viewed here: Deep Dive into the EOT 25.10.23
Douglas kicked off with a summary of the recent Employee Ownership Association report that showed employee-owned firms experienced uplift in productivity from 8-12%, and are more likely to invest in R&D. It is also showed that employee-owned firms drive more GVA than conventionally structured businesses.
Douglas then turned to the specific benefits that employee ownership delivers to the company, the employees, the sellers and the economy. Higher engagement and happier customers are good news for the company, and employees can benefit from a capped tax-free bonus and more secure employment. As well as the exemption from Capital Gains Tax, the sellers can manage their own exit from the business.
Money is not the key driver for sellers in Douglas’s experience. Sellers are more often motivated by the desire to protect the company’s ethos and values, and preserve the employment of local staff. The EOT transaction tends to be a friendlier and more collaborative sale than other commercial deals.
Nimarta picked up the presentation to explore the mechanics of the EOT transaction.
She talked through the statutory requirements of the EOT transaction, emphasising that any breach of these requirements could have quite serious consequences for the sellers and/or the EOT.
Douglas then talked through the financial aspects of the deal. The transaction is almost always funded by the company – whether that’s by the company gifting funds to the EOT to make the initial payments and deferred consideration payments, or by the Company seeking external funding from a third party. Douglas said there is more of an interest from banks and specialist lenders for funding EOT transactions, although the company should scrutinise closely the costs involved.
Douglas always recommends detailed tax advice is taken and that clearance is sought from HMRC as part of the transaction. He advised that companies should be careful to set a fair market value for the business. An over-valuation might stress the company and lead to negative outcomes.
Nimarta explained the governance structure of the company post transaction; specifically, the composition of the target company board and the trust board. The important consideration is that the company continues to function effectively and if this is an exit plan, there should be some leadership succession planning underway. It is usual for the seller to have a position on the trust board, and there would almost always be employee trustees. The value of appointing an independent trustee was emphasised, although finding the right candidate can be challenging.
Nimarta touched on “Reserved Matters”; areas where the target company board must seek approval from the trust. This recognises that the company’s executives are making decisions that might impact on the employees’ value in the company and serves as an additional layer of scrutiny to ensure the company is taking well-considered actions.
There may be some additional tidying up required such as ensuring that employment contracts are up to date, particularly for sellers who may then become employees of the company.
Nimarta finished up by touching on the warranties and indemnities in the share purchase agreement for the transaction, which tend to be quite light touch in EOT transactions compared to arm’s length deals.
It was a well-delivered informative session and a number of questions were asked in the Q&A.
Question and Answers
Q. What companies can’t do an EOT?
A. The EOT model fits well across all sectors and for companies of all shapes and sizes. Potential issues might arise if the company is loss-making (and can’t afford to fund the transaction) or carries too much debt (and lenders will not allow change of ownership or new lending). Also, if this is an exit plan and there is no management capacity to take over the reins from the sellers, then they will not be able to achieve their desired exit. Leadership succession planning is as important as ownership succession planning.
Q. Who is the law firm acting for?
A. TLT will usually act for the company, with the aim of delivering the best outcome for the company, which should also achieve a good outcome the seller and the EOT. The seller and the EOT are each always advised to seek their own advice, although most tend to be comfortable that their interests are well looked after as they have been involved at every stage of the process.
Q. Why do you think interest is accelerating as it seems to be?
A. It’s a great model! Awareness is growing and the number of enquiries is increasing. There are so many fantastic success stories which make a persuasive case for a sale to an EOT. The CDS team do a brilliant job in supporting companies take this step.
Q. What do you think the outcomes of the consultation might be?
A. Hopefully, more clarity around some of the terms of the legislation. Some pointers on what is acceptable in terms of seller protections would be useful. It would also be good to see an uplift in the bonus threshold which has remained static since 2014.
Q. Do you think a new government might withdraw the tax exemption?
A. Highly unlikely! The tone of the consultation was very supportive, and the strong message is that HMRC is looking to make the EOT more attractive, not put obstacles in the way. We should be confident that employee ownership has cross-party support and any move to remove the tax exemption is likely to be very unpopular.
Q. Do you think employees have enough say when this is an Employee Ownership Transaction?
A. It’s a fair point. It is usual to have employee trustees but sometimes they are not appointed until late in the process. This is where a specialist employee ownership adviser can be invaluable. They will often present the point of view of the employees and ensure their interests are centred in the new structure going forward.
Q. What could the Scottish Government do to encourage more companies to adopt the EOT?
A. It’s Douglas and Nimarta’s opinion that CDS already do a brilliant job in selling the EOT message. The virtual events are excellent and the in-person sessions where you can mingle with interested parties, advisers and employees from employee-owned businesses are excellent. Could more be done? Always. Funding remains an issue and it would be great to see more direct funding towards employee ownership. While awareness levels can always be raised, there’s already a strong employee ownership community in Scotland which has grown steadily in such a short time.
Douglas Roberts is a partner in the Corporate team at TLT LLP with over 23 years’ experience of advising on corporate legal matters including M&A, equity investments and corporate advisory work across a broad spectrum of clients, including SMEs, family businesses and start-ups. He is recognised as one of Scotland’s leading solicitors on employee ownership, having assisted with more than 35 transitions to employee ownership, including Kidzcare, Alan Steel (Asset Management), The Scottish Gallery, Your Equipment Solutions and Reid & Fraser. He has also acted for Capital for Colleagues plc regarding investments in employee-owned companies. He is qualified in both Scotland and England & Wales.
Nimarta Cheema is a Senior Associate in the Corporate team at TLT LLP who specialises in M&A transactions with a focus on employee ownership. She advises a range of clients, including owner-managed businesses and large companies across different sectors and is knowledgeable in a broad range of corporate transactions, including acquisitions, disposals, private equity investment, corporate reorganisations and general corporate matters. She is an experienced employee ownership adviser, having advised on some of Scotland’s largest employee ownership transactions such as Carlton Bingo and Guitar Guitar.