Quick Guide to Employee Ownership Business Sales

Why sell to an Employee Ownership Trust (EOT)?

EOT businesses are not new – John Lewis is probably the oldest example. Many owners are now choosing to sell their businesses to their employees via employee trusts because of the many advantages. In particular:

    1. EOT sales are highly attractive because subject to HMRC clearance, they are 100% tax-free; the Government is incentivising such sales as there is significant evidence that EOT’s are sustainable and lead to greater productivity.
    2. There are benefits for the employees: tax-free bonuses, better job security, and a feeling of inclusiveness.
    3. The process can be vendor-led and employees are not required to drive the approach as would be the case in a Management Buy-Out (MBO).
    4. They are more immediate and require less due diligence than trade sales.

What is the sale approach?

An EOT sale does not mean that the business has to become wholly run by the employees. The former shareholders can remain involved at management level; although they concede board control of the business to the Trust they can take a position as a Trustee after the sale. The key points of the EOT approach are:

    1. The sale must be for 51% or more of the company shares to benefit from the 0% CGT rate. Many EOT sales are 100% share sales for simplicity
    2. Typically a new company is created which will act as the employee share ownership trust and the shareholders sell their trading business shares to this EOT company.
    3. A sale and purchase agreement is executed, although associated due diligence is typically lighter.
    4. After the sale, the company trades as a wholly-owned subsidiary of the EOT company.
    5. A trust document sets out the obligations of the Trust to the employees.
    6. The fixing of the multiple used to value the trading company is a commercial discussion and there is no golden rule.

How will my business be valued?

Typically, private company valuation multiples range between 4 to 7 but cashflow, financial headroom and reserves will all have a bearing. The valuation, which will be led by Avondale, is subject to HMRC clearance and will be assessed using comparisons with other private sale benchmarks.

How will the sale be funded?

There are three ways for the Trust company to fund the buy-out – company reserves, vendor loans (typically over 5-7 years from our experience), and sometimes third-party debt is also used. Financial aspects to consider:

    1. Any debt or vendor loans are structured in much the same was as a management buy-out from future cashflow (profit after tax) – analysing seasonality and the headroom to pay debt plus interest from the income.
    2. Owners’ salaries are sometimes adjusted at the point of sale.
    3. The trade company will make payments out of profits after tax on the vendor loan to the EOT company which will then repay the selling shareholders.
    4. The vendor loan is often a ‘promise to pay’ and therefore may not sit on the balance sheet. From a practical perspective this means that if cash flow is struggling, the loan period can be extended.
    5. Interest on vendor loans must be charged to ensure that there is an incentive for management and Trustees to repay the loans on schedule.
    6. Dividends can be restricted until all vendor loans or third-party loans are paid off.
    7. The vendor loans are typically structured as loan notes secured against the business.
    8. Any initial payout from reserves needs to leave sufficient working capital.
    9. Any third-party debt may need personal guarantees from the sellers and will take precedent over the vendor loans in terms of repayment. The trust needs to approve reasonable finance terms.

What happens to the employees?

Employees are usually highly motivated by employee ownership. They like the inclusivity and cultural approach that it brings to the company and their roles. It also benefits the recruitment process. Many employees also see that beyond any debt repayments the business can scale-up as the ongoing dividend requirement is lessened/eradicated. Typical benefits include:

    1. Following debt repayment, pay for key managers is typically in the upper quartile for the sector.
    2. Increased retention.
    3. Better productivity as staff increase the ‘stakeholder’ mindset.
    4. Tax-free bonuses of up to £3,600 per annum for each employee, typically from year one.
    5. The sellers can remain employees and gradually handover the reigns over-time, as appropriate.
    6. Strategy and culture can often be reset with increased team-driven initiatives.
    7. The trust acts in the best interests of the beneficiaries – the employees.
    8. Usually, there is a professional trustee, an employee trustee and an ex-shareholder trustee. Avondale will help establish your trust panel as part of its service approach.

What are the next steps?

All EOT sales are bespoke as the approach is highly flexible. It typically takes Avondale 2-3 months to complete an EOT, working directly with the sellers on a one-to-one basis on all aspects from feasibility, finance and clearance to strategy and the establishment of the trust panel.

With significant expertise in valuing businesses, cash flow modelling and gaining HMRC clearance, we are unique in the EOT market as we also have in-house hands-on expertise to lead the EOT cultural transition within a business. We believe EOTs should be completely commercial in terms of the return to the seller shareholders, and then on sale, the business should become an employee-driven strategically advantaged business.

For further information on employee ownership business sales, book a meeting with one of our consultants or call us in confidence on +44 (0)20 7788 8250.