EOT stands for Employee Ownership Trust and was introduced by the UK Government in 2014 along with a package of incentives aimed at making it an attractive option for shareholder exit, as well as for employees.
Although it was introduced almost 10 years ago now, that still makes it relatively new in terms of available options for shareholders looking to exit their business. In addition, they are becoming an increasingly popular option…
Employee Ownership Association Chief Executive, James de le Vingne says;
“Just as electric cars are the next generation of transport… EO can and will be a next generation business model. A forward-thinking, future-proof solution that helps us realise a far more productive future. … A business model that is superior to everything that has gone before – a way of working together that benefits EVERYONE and allows them to fulfil their own individual potential, as well as the potential of their businesses and their communities.” 2022 EOA Annual Conference keynote speech
So, what are the main features of an EOT and why could it be the best option for you if you want to sell your business?
What are the main features of an EOT?
The primary feature of an EOT is that, instead of selling a controlling share in the business to another company or external investor, a controlling share in the business is sold to the staff. This is done through the vehicle of an independent trust which is set up with trustees to ensure appropriate governance and representation.
The other vehicle for putting the company in the hands of its employees is an MBO or Management Buy-Out, although typically this is to a smaller group – usually the senior management team. The other main difference is in the terms of the deal and how the shareholder exit is structured.
With an Employee Ownership Trust the agreed deal value will be paid to the exiting shareholder from the ongoing profits of the business over a period of time, which could be as much as 5-7 years. As opposed to a trade sale, this means there is typically little or no money on day one. The exception to this is if there is significant surplus cash within the business, which can be taken out as part of the deal.
Why is it a good option?
Research conducted by the Employee Ownership Association in association with Capital Strategies shows that employee-owned businesses can be just as competitive, productive and vibrant as owner-managed businesses. In fact, they stand a very good chance of being more competitive and productive. This is because ownership of the business usually has a very positive influence on employees who are more invested in doing their part to contribute to the success of the company. If the pathways to contributing ideas and opinions are well mapped out, this is even more so.
There are also financial benefits for employees who, as indirect shareholders, can benefit from a share of the profits, the first £3,600 of which is tax free.
Employees are not the only beneficiaries of course; the exiting shareholder is also able to take advantage of some great incentives. The primary one is that any EOT buy-out of a majority shareholding is not subject to capital gains tax, which you would normally pay on business sales.
This tax-free status also counts towards any surplus cash in the business meaning it is a very attractive option for businesses that are highly cash generative or have significant cash reserves.
Another reason that an EOT might be an attractive option for your shareholder exit is that it keeps the business in the hands of those who know it best. Trade sales and other types of acquisition can be fraught with teething problems on handover. Different ways of working, different terminology and incompatible systems are just a few of the hurdles you could face. Transitioning ownership to an EOT on the other hand is normally much smoother as the only real handover required is anything that you, as the now former owner, were solely responsible for. This is usually much easier with a team that already know the business and the client base.
For many business owners that we speak to, personal issues like money and time are only part of their thought processes around shareholder exit. One of the key considerations for our clients, outside of the obvious, is the staff that have been with them for so many years, some that have become more family than personnel. An EOT is a great way to reward loyalty and to ensure that staff are well looked after moving forward, as well as benefitting directly from the sale.
While we do everything we can to minimise their impact on a trade sale, some level of earn-out is present in almost every deal as they reduce risk in the eyes of an acquirer, and therefore have an upward pressure on values. The challenge for most exiting shareholders, is that most earn-outs are tied to future company performance… the one thing you have less control over as you transition out of the business. In an EOT scenario, however, it is easier for the exiting shareholder(s) to influence the performance of the business over the earn-out period, meaning more certainty of success and achieving the full value of the company.
Who determines the value of the business?
In a traditional trade sale we would advise strongly against putting a value on the business because you want to emphasise the value drivers, create competition and allow that to drive out the maximum value according to the buyer’s motive. Of course that is not possible when considering an EOT, so how do you determine value?
In essence the value of the shares is down to the exiting shareholder(s) to determine… but hold on, that doesn’t give you a licence to print money! The valuation has to meet two criteria – 1. it has to be approved by HMRC as a fair and reasonable market value, and 2. it has to pass the common sense test and be realistically achievable from the expected company profits, or you will simply drive the business into the ground or be waiting forever for the money.
This is one of the key areas where an adviser like Entrepreneurs Hub can help you. By working with our team of highly experienced and senior FD/CFO level analysts, we will determine a fair market valuation based on expertly modelled financials and well researched industry multiples.
Do you have any examples?
We do, however, due to issues of confidentiality and out of respect for our clients’ wishes we cannot reveal the details in this format. If you wanted to meet with us to discuss how your own business could transition to an EOT, we may be able to share more detail than we are able to in a public forum. However, here is what one of our clients said about a deal we have done…
“The Entrepreneurs Hub helped us prepare for, and supported us through, the whole process to transition to an Employee Ownership Trust. Our employees are now motivated and know this is a great opportunity for them. Highly recommend the Entrepreneurs Hub to any business owner considering an EOT.”
Mathew Hughes, Managing Director – NWPS Construction Limited