Selling Up? Then think about an EOT

Accountancy: Ensors Chartered Accountants

Sellers in the financially comfortable bracket, who would like to reward their employees, have a relatively new option – setting up an Employee Ownership Trust (EOT). This route will not necessarily maximise proceeds or lead to the quickest receipt of funds, but it can protect the ethos of the business.

For illustration, a business purchase by a trade buyer could see something like 60% to 70% of the consideration paid on completion, plus the surplus cash saved in the bank. The remainder is then paid over an agreed period, perhaps based on future profits. This means that a large slice of consideration is received immediately.

Selling up? Consider an Employee Ownership Trust

An EOT is different. It involves the sale of control to a Trust, which holds the shares for the benefit of all qualifying company employees. The employees participate in the Trust rather than own their share in the business, so they don’t have to put up the cash.

Putting aside the possibility of bank funding for the moment, no new money from a trade buyer means that the completion payment can only come from the spare money within the business that is not used for trading purposes. Therefore, the trading value of the business (Enterprise Value) will remain outstanding as deferred consideration and satisfied out of future profits.

Although the seller would probably be confident that trading will remain steady, there is undoubtedly an element of risk to any outstanding amounts until they get paid.

The lack of new money creates a second quandary – the price. EOTs can purchase the shares at a market rate. However, if growth is not achieved, it can lead to a long payback period which could demotivate staff. For example, consider a business valued on six times the common metric of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation). Theoretically, it would take six years of achieving the same profits to pay this off. But the actual payback period is extended as costs, such as interest, tax and capital expenditure, are all real cash outflows that will limit the ability to pay back the deferred consideration. In this example, the actual payback period could easily be ten years.

Most owners, therefore, set the price at the lower end of the valuation range or even below to reduce the potential payback period length.

Accepting a potentially lower price and a slower payment period demonstrates the selflessness that these structures require. It’s why it is disappointing that many commentators focus upon the 0% rate of Capital Gains Tax on sales to EOTs as if it were an elaborate tax-dodging scheme. An EOT requires great commitment from a seller, and the 0% tax rate is merely a way of partially rewarding this.