Is Selling A Company to an Employee Ownership Trust Right For Every Business Owner?
Is selling a company to an Employee Ownership Trust right for every business owner? In years gone past, an SME business owner wanting to sell his / her company would have limited options. These would be typically a trade sale, a management buy-out (MBO), a management buy-in (MBI), or a sale to private equity. And very occasionally, an IPO.
Today, we have the added option of selling to an Employee Ownership Trust (EOT).
Perhaps anecdotal, but when speaking to a myriad of accountants over recent years, it seems their de-facto advice to business owners seems to be that selling to an EOT should be one of the first considerations if an ‘exit’ is on the cards.
Why is this advice from accountants so (apparently) prolific?
Is every SME company ready for an EOT? Or is an EOT suitable only for a few?
Let’s look briefly at the history of EOT’s…
Worker owned co-operatives were established in the 1960’s, and in 2014, the UK government introduced the Employee Ownership Trust model through the Finance Act. EOTs provide a tax-efficient mechanism for business owners to sell their companies to a trust set up for the benefit of employees. In fact, capital gains tax for EOT deals can be 0% – pretty attractive for a business owner!
But… tax was not the primary driver when the UK government created the EOT model. In fact, the government created the EOT with a motivation to foster a business environment that encourages sustainable growth, fosters employee engagement, and supports entrepreneurship. In short, taxes were set low to encourage business owners to align their interest with broader economic objectives of fostering a more inclusive and resilient economy.
We see the benefits of an EOT, but having taken one company through an EOT process, we are not sure that this is suitable for every company exit.
Why so?
1. Valuation and Price
The valuation of the company and the price offered by the EOT may not align with the expectations of the seller. While an EOT sale can offer certain tax advantages, the price offered may be lower than what could be achieved through a sale to a third-party buyer, particularly if there are multiple interested parties driving up the price in a competitive bidding process. We have occasionally seen exit multiples ratchet up by more than 100% in some cases when negotiating between multiple bidders – this could simply not happen with an EOT.
2. Deal Structure
Few companies have the cash (liquid assets) to pay the business owner in full for the deal. In almost all cases, the company either has to borrow money and / or the company agrees to pay over a period of time out of future profits – typically 3 – 7 years. That means that the company is effectively ‘on the hook’ for a long period of time to pay the deal value out to the business owner. This can (significantly) reduce the ability of the business to invest – in effect, until the total deal value is paid out.
Do employees want to be left in a business that is highly leveraged for a long period? How will they feel when they realise the amounts involved that need to be repaid?
3. Potential for Reduced Control
When a company is sold to an EOT, the ownership of the company is transferred to the trust, which then holds it on behalf of the employees. This means that the original owner(s) lose some or all control over the company, as decisions are made collectively by the trustees and potentially by the broader employee base through mechanisms like an employee council or board representation. In fact, HMRC have recently announced it is looking closely at this point to ensure that control has effectively been fully transferred to the trust, as opposed to being a proxy solely for the original owner(s)!
The point here is clear – when sold to an EOT, the owner simply does not have the same control as he / she enjoyed prior to the sale.
4. Risk of Disagreement and Conflict
With ownership dispersed among a broader group of stakeholders, there may be an increased risk of disagreement and conflict over strategic decisions, company direction, or distribution of profits. This can potentially impact the company’s ability to operate efficiently and make timely decisions, especially if there are divergent interests among employees or between employees and management.
5 Talent
Not every business has an entrepreneurial leadership team! In fact, many smaller companies are heavily reliant on the original owner to have provided leadership through the course of the business.
Does the company have the necessary commercial talent to ensure it continues to prosper in the years ahead? Can it retain that talent in a highly competitive commercial environment?
6. Complexity of Structure
Establishing and managing an EOT involves legal, administrative, and governance complexities. It requires that the employees are consulted through the sale process on all key commercial and legal points. It should not be simply a ‘done deal’ that is presented to the employees as a ‘fait accompli.’ Setting up the trust requires careful planning, legal documentation, and ongoing management. The seller may need to invest time and resources to ensure compliance with regulations and to navigate the intricacies of the trust structure.
7. Exit Strategy Limitations
Selling to an EOT may limit the options for future exit strategies. It is entirely possible that a company is taken out of an EOT by way, for example, of a downstream sale to a trade buyer.
But the question remains – will this be to the advantage, or disadvantage of the employees? Our view is that some EOT’s will come on the market in the next 5 – 20 years that will have reduced in value, or in fact, will be distressed exits. Why? Because many will have lacked investment and entrepreneurial drive.
Taken on a single metric, e.g. capital gains tax, then EOT’s can look attractive. But not every company is right to be sold to an EOT.
When considering an EOT, as well as looking to maximise the value for the outgoing shareholders, the ultimate question should be:
Is this the best decision for the future prosperity of the company and its employees?
If the answer is ‘yes’, then an EOT may just be right for you. But if you are making the decision solely based on the tax advantage, might be time to think again…
Want to discuss your options, then contact us now for an objective view.
Tags: Employee Ownership Trust, EOT, IPO, management buy-in, management buy-out, MBI, MBO, private equity, selling a company
