Our Employee Ownership Explained webinar series for 2023 concluded with Linzi Wilson from Consilium Chartered Accountants. In this webinar, Linzi talked about valuing and selling a company to an EOT (Employee Ownership Trust). You can view the recording of the webinar below.
The client base of Consilium comprises primarily owner-managed and SME businesses and at some point the owners have to consider their succession options. There is a duty on all advisers to support their clients in making the best, most informed decision for their particular circumstances. It will not fit with every business, but it is important that the EOT is presented as an option.
The EOT can be attractive to business owners for a number of reasons. To an extent it allows a business owner to be in charge of their own destiny. They can set out a clear timetable. The structure to allow their exit to be planned can be planned even a good few years in advance. They are not working to somebody else’s timetable, which would be the case if they were selling to a trade buyer.
It also gives the owner time to develop and train a new management team to take over running the business. We regularly experience situations where the owner is absolutely still heavily involved in running the business and there is no ready-made management team waiting to take over. A lot of Consilium clients have grown their business from day one. It can be pretty daunting to consider selling this on to an unknown entity where they have little or absolutely no control over what the future has in store for the business. The EOT can remove that uncertainty and can protect the ethos of the business, for the employees and for the customers.
The process to implement an EOT tends to be less costly in comparison to a third-party sale and is probably less intrusive and can offer and enhanced confidentiality. It’s more than just a financial transaction.
Awareness of EOTs has improved significantly over the years. There is plenty of publicity – all of it positive – when new EOTs are announced. This is another boost for the business owner – it’s always nice to leave a positive legacy and the PR around EOTs tends to do that. Although awareness is greater, there tends not to be much knowledge around the detail and how things work to make the EOT happen.
The EOT isn’t the right fit for every business and there is a process that needs to be undertaken to determine whether the EOT is appropriate for the business. It does transcend sectors and we have seen a range of business sizes, turnovers and values.
There are a number of qualifying conditions that must be met to qualify for the tax reliefs. The tax team within Consilium would prepare a technical report to confirm that any disposal to any out would meet the conditions and the legislation that would allow the business owner to qualify for the 0% tax rate available for the qualifying disposals. Of course, the business has to be financially sound. Generally, the same indicators that would warrant being a successful business in a trade sale would apply for the company to be successful as an EOT.
Valuing the business for the EOT transaction is no different from valuing a business from the more usual commercial transaction. There are a number of things to look at such as the valuation method that is most appropriate, the sector of the business. Underlying profitability might be a factor and consideration of any excess assets or company debts. Is there a cycle for working capital. Every business valuation is done on a case-by-case basis where appropriate. For EOT transactions which are largely funded from the company’s profits, then the valuation must be affordable for the business.
It’s not true that business owners should expect to receive less financial value from an EOT transaction. There have been occasions where an owner has discounted the price in recognition of the loyalty of employees and their contribution to business success but that has been their choice to do so.
The repayment schedule must allow for any fluctuations in trading performance or any variances in cash that would allow the seller to benefit in times when there are larger cash surpluses. It’s usually to make provision for the company to over pay when the cash is available to do so. But equally the EOT would want to have the comfort that a regular payment may vary should cash be a bit tighter on at certain months. It’s not in anyone’s interest to overpay deferred amounts and cause the business any unnecessary financial hardship. All parties need the company to have the wherewithal to continue to be successful.
A typical repayment period would be in the region of 5 years and many companies do manage to pay the debt more quickly than this. It’s important that the employees don’t see the debt as an interminable burden on the company with the end date very far in the future.
It’s important to seek clearance from HMRC in advance of completing the transaction. It’s usual to seek approval that the transaction qualifies for the tax relief and that any contributions to the trust will not be treated as dividends and taxed accordingly.
There is an increasing appetite from lenders to support EOT transactions. In some situations, the company’s incumbent financer has extended existing facilities to assist with the transaction. However, it is more usual for EOTs to be funded solely from the company’s profits.
The EOT transaction has worked well in most cases with companies delivering even more successful results than forecast and this is reinforced by research that employee-owned businesses are more likely to outperform conventional companies.
Questions and Answers
Q. Is there anything wrong with the company’s own Financial Director doing the valuation and the and the accountancy?
A. It’s not wrong. However, an independent valuation will probably lend more credibility to the process. It is much better if a tax specialist submits the HMRC clearance; the risks are significant if that is not completed correctly.
Q. What’s the ideal payback period for deferred consideration to be repaid?
A. This is difficult to put a number on. The usual timescale would be around 5 or 6 years.
Q. Is it possible to include a golden share as part of the transaction to give some protection to sellers during the restricted period of deferred consideration when they are exposed to risk?
A. The Golden Share would allow the seller to override every other shareholder, including the EOT, and therefore would likely be seen to contravene the Controlling Interest requirement in the legislation.
Q. Could you share any insights as to the features and benefits of the EOT for employees, particularly in terms of how they can expect to financially benefit in the future
A. Putting the financial aspect to the side, I think the prime benefit for an employee in a company pursuing an EOT rather than a trade sale is that they will have continuity. Nothing will really change for them. They’ll probably have a bit more security around their employment. In financial terms, there is obviously the tax-free bonus that can be paid to employees of up to £3600 per tax year. The company can pay more than that, but it will be taxed.
Q. Are professional fees incurred setting up at the EOT deductible against tax for the selling company?
A. The tax impact should be considered on a case-by-case basis. The treatment of professional fee costs would need to be considered, including whether these can be billed to the company to any extent or whether they should be billed to the shareholders as vendors or the EOT as the acquiror.
Q. Is interest on the outstanding vendor loan deductible against corporation tax for the company?
A. No. As the loan is between the EOT and the vendor, the company is not a party.
Q. Do you see any common themes or trends for business sectors going down the EOT route against the trade sales?
A. There doesn’t seem to be any prevailing trend. There have been a number of manufacturing companies but that might be more of a reflection of our client base than a trend in the market.
Q. If the company’s performance improves, will the sellers have the opportunity to be visit the valuation post transaction?
A. No. The valuation is set and the price is agreed. It is the same with the trade sale. The buyer won’t pay more unless a mechanism has been pre-agreed and incorporated into the transaction. If the company is sold relatively soon after the EOT is in place, then if there is an anti-embarrassment provision in place the seller might recoup some value that way.
Q. If there’s a disagreement between the trading company and the EOT on distribution of profit share, who has the final say, the trading company or the EOT?
A. It’s the company that pays out the surplus profits in the form of the tax-free bonus. However, if the trust thought that the company directors were not acting fairly in the best interests of the beneficiaries then they may exert their authority over the board and demand a change in policy.
Q. What are the typical costs for accountancy advice in an EOT transaction?
A. It’s impossible to be specific in this. All companies will be different in what is required and how much input is needed to do a proper assessment of the business and its prospects. As reinforced earlier, tax expertise is critical. It’s important that the advice is appropriate.
Q. If the company sells them future and do the employees receive the proceeds tax free?
A. No, the trust will be liable for Capital Gains Tax on the proceeds of the sale, and employees will be charged income tax at their prevailing rates on their share of the distribution.
Q. Any advice for advisers when discussing succession with clients?
A. It would be wrong not to put the EOT option on the table as part of that discussion. It can be exactly what the outgoing business owner is looking for. If it doesn’t fit, at least you can be sure you have helped the client make an informed decision.
Linzi Wilson CA joined Consilium Chartered Accountants in 2013 when the firm was established. As Corporate Finance Partner, Linzi assists her clients with a range of lead advisory and financial due diligence services.
A qualified Chartered Accountant since 2005, Linzi has over 17 years of experience within the Corporate Finance advisory sector. Linzi loves her job and highlights the people, the office banter and chilled atmosphere as the best aspects of working at Consilium. When Linzi isn’t helping Consilium’s clients, you will find her climbing, kayaking or cycling her way around Scotland.