Comparing Employee Ownership Trusts (EOT) and Trade Sales: An Overview

EOT

Trade Sale

Headline nature

A sale to a special entity trust that will be established for the benefit of the existing and future employees.

Sale to a third party or private equity/investor group.

Control

Seller would remain in control of the process.

Once Heads of terms signed the buyer tends to take control

Due diligence

Simplified. Most companies have skeletons, and these should be mitigated to avoid embarrassment in the future.

Possible due diligence by funder where an institution is involved.

Any offer is subject to detailed due diligence, by the buyer and maybe their funder. More questions throughout process, partly due to the lack of knowledge of third parties of the business.

Exit

It is a partial exit and in view of the unlikely trade sale in the future (see below), a cul-de-sac.

Seller is out altogether

Culture/Legacy

Higher chance of continuity of culture and legacy as it puts employees at the heart of the business, this may be true if management are incentivised by way of an EMI Scheme. Going forward, employees decide this for themselves.

At risk as it is not unusual for the culture to be eroded to be aligned to that of the buyer, which may impact on the legacy of the business.

Employees have little or no control, especially if there is an earnout with no protections.

Benefits for employees

Job security, retention of culture, leadership succession and financially they may receive a tax-free share of the profits of £3,600 given sufficient cash and profitability.

Subjective based on an employee’s ability and role. Chance to be part of a larger company with progression opportunities.

Redundancies

Peer pressure.

Possibly.

Consideration and funding

Funded by the company. The initial payment to seller dependent upon the surplus cash in the business with the deferred payment (Loan) secured by a guarantee from the company which is only worth something if the seller is confident the transaction will be fully funded.

Cash on completion and, hopefully, negotiated security for any loan. Earnout unsecured as to both performance, profitability and payment.

Customers and suppliers.

Relationship can be retained.

Terms of trade could be altered.

Deal Terms

Likely to be the easiest to arrive at as primarily arrived at by the seller. Valuation needs to provide a reasonable rate of return for the Trust

The seller would want the highest possible consideration tempered by other terms making negotiations tough and stressful.

Structure

Initial consideration dependent on the company’s reserves and any additional funding that could be raised. Usually, the balance paid over 5-8 years and maybe the bank would take out the balance of the loan at some future point.

Typically, 60% – 75% paid on completion with balance tailored to deferred arrangements usually over 1-3 years along with an earnout element.

What happens if it all goes wrong

Deferred payment may not be forthcoming if the company is unable to meet its obligations.

A holding company should secure deferred payment at least i.e., not just the target company.

Skills to take the business forward.

Usually the seller feels (s)he has taken it as far as (s)he can. Future growth dependent upon the key employees.

It is likely to be a mature business.

A larger organisation would have the skills and resources to take the business forward; otherwise, why do the deal. The seller maybe required to remain for the period until all the outstanding consideration has been paid.

Loan repayments

The key employees and financial controller will need to have the discipline of cash management. Cash flow projections on a yearly basis with particular attention to the timing of rent, VAT, loan and Capex expenses together with a more detailed rolling 13-week period are necessary. Maybe credit control procedures need to be reviewed.

Reliance on buyer to meet its liabilities. Any surplus cash after completion will go to the other companies in the group.

Legal protection for seller on unpaid deferred payments

No personal guarantees, so no legal action can be taken against the Trust for non-payments. The seller may continue in a non-executive role until at least remaining consideration paid.

Some form of guarantee or a charge over the buyer’s shares.

Seller retained shareholding

Available along with dividends once loan repaid.

Maybe depending upon the buyer’s deal structure.

Valuation

It must provide the EOT with a reasonable rate of interest, and a discount may be applied due to the tax saving.

HMRC are conscious the gain on the first sale of the seller’s shares is tax free, thus the consideration must not be primed. Tax clearances must be prepared.

Market price so no quibbling with HMRC. A premium valuation can be achieved especially in a strategic sale as opposed to a financial sale.

BADR applies to the gain.

Repayment of loan

Dependent on company’s cash flow. The bank may take on the loan after, say 3 years once they see it all working.

Likely to be 5-8 years.

Less dependent on one company’s cash flow and shorter repayment period.

Relationship with the company’s bankers

Where there are loans and debentures the bank needs to be consulted and, arguably, kept informed on a regular basis at least for the first couple of years. Bank policies can change but where EBITDA is projected to be >£500,000, there should be some comfort once feasibility study completed.

Irrelevant

Transaction costs

Circa £50,000 plus VAT and stamp duty based on limited due diligence.

Higher, especially if external funding required.

Summary

·       There would be no need to find an external buyer.

·       Easier negotiations

·       No CGT provided clearance obtained.

·       Reward to employees.

·       Legacy and culture can be retained.

·       Potential to achieve a higher valuation especially if several interested parties.

·       Resources to unlock potential and grow the business at a faster rate.