Employee Ownership Trust Guide
Establishing an Employee Ownership Trust (EOT) can be a great way for some owners to realise the value of their business whilst leaving a positive legacy through the remaining business. An EOT is an indirect form of employee ownership in which a trust holds a controlling stake in a company on behalf of its employees, the most well-known example being the John Lewis Partnership.
An increasing number of owners are now assessing the benefits of selling their businesses to their employees via trusts versus an open-market business sale. This process can be vendor-led, does not require the employees to drive it and valuations are a commercial discussion with no requirement for the involvement of a 3rd party. Due diligence is light, and the transactions can be funded against an agreed schedule, thereby enabling sellers to both reward and handover over time. There is also the 100% tax-free aspect which is highly attractive.
Our in-depth Employee Ownership Trust Guide answers frequently asked questions and helps business owners and management teams to better understand how an EOT may help to realise value and leave a positive legacy through the remaining business.
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Why sell to an Employee Ownership Trust?
EOT businesses are not new – John Lewis is probably the oldest example. An EOT sale has many advantages, in particular, such sales are highly attractive because, subject to HMRC clearance, they are 100% tax-free. In fact, the Government is incentivising such sales as there is significant evidence that EOTs are sustainable and lead to greater productivity and better support of the economy.
- There are benefits for the employees in terms of tax-free bonuses, better job security, and a feeling of inclusiveness. This form of sale aids motivation and staff retention.
- 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). EOT sales are also more immediate and require less due diligence than trade sales.
- The fixing of the multiple used to value the trading company is a commercial discussion and there is no golden rule.
What is the employee 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 a trust but they can take a position as a trustee after the sale. The key points of the EOT approach are:
- 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.
- 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.
- A sale and purchase agreement is executed and after the sale, the company trades as a wholly-owned subsidiary of the EOT company.
- A trust document sets out the obligations of the Trust to the employees.
- Once the seller pay-out is achieved, key managers typically end up in the upper pay grade for their sector.
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 EOT valuation, which will be led by Avondale, is subject to HMRC clearance and will be assessed using comparisons with other private sale benchmarks. The Government is actively promoting the employee ownership business model therefore proceeds from qualifying sales are at 0% tax.
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 are:
- Any debt or vendor loans are structured in much the same was as a management buy-out from future cashflow (profit after tax) – it is therefore important to analyse seasonality and the head-room to pay debt plus interest from the income.
- Owners’ salaries are sometimes adjusted at the point of sale.
- 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.
- 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.
- Interest on vendor loans must be charged to ensure that there is an incentive for the management and trustees to repay the loans on schedule. Dividends can be restricted until all vendor loans or third-party loans are paid off.
- The vendor loans are typically structured as loan notes secured against the business.
Any initial payout from reserves needs to leave sufficient working capital. 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.
*For further resources, including articles, webinar recordings and insights, visit the Resources section of our Employee Ownership page.
Discuss your Employee Ownership Trust Options in Complete Confidence
Avondale are the only advisor providing a turnkey solution that covers legal, financial, trustees and consulting.
This means we deliver the right structure at 0% tax and also ensure it works. We believe that EOTs should be commercial in terms of the return to the seller shareholders, and create a purposeful, employee-driven and strategically advantaged business post-sale.
Talk to one of our employee ownership specialists to understand how an EOT could work for you.