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Employee Ownership Trusts

 

In this blog we examine an alternative option for selling a business, Employee Ownership Trusts, or EOT’s. EOT’s are a relatively new but growing alternative to a standard sale of a business, especially where there are more complex succession issues, and also where it is intended to reward employees of the firm. There is some complexity to EOT’S, but salient features can be summarised as follows:

  • A recent independent report found that among employee-owned businesses, there were increased levels of productivity and efficiency, improved workforce retention, easier recruitment and employee-driven innovation.
  • An EOT offers an attractive route for those prioritising the legacy and culture of the business.  It’s more a philosophical decision than a financial one.
  • An EOT can be the best solution for a business to keep the whole team in place and to provide continuity for a creative culture, with those that create value in the company continuing to benefit directly from that value.
  • Employee ownership requires two things.  There must be a mechanism where the ownership can be shared among all employees.  Equally the business has to have a culture and a structure where employee influence and voice can be shared.  The two are intrinsically linked, otherwise all the benefits will not be achieved.
  • There are three requirements that the EOT ownership structure must meet.  First, all employees must benefit.  Second, they must benefit on an equitable basis.  And third, there is the “controlling interest” requirement – essentially the trust must have control in different ways over voting rights and profits.
  • With an EOT the trading company effectively funds the transaction itself, so the majority of transactions are funded by vendor loans or deferred consideration. These are repaid by the trading company, although excess cash could be used to make a repayment at completion.  A minority will also get third-party bank debt again taken out by the trust, which will also be repaid by the trading company.
  • One EOT characteristic for the selling founder is that they will not usually get full payment on completion, although it is not uncommon for a “philanthropic” owner to compromise on price. 
  • One issue is how the deal is funded. Being people-heavy and asset-light, there may be little security against which to raise debt for growth. However, providing it is well structured, there should be headroom in the repayment schedule, which allows for operating cash to fund growth.
  • Another issue is that a potential disadvantage is the inability to get cash out. But it is effectively long-term “patient” capital, which is what the founder wants, because they want to see the name remain and their business continue to grow.
  • The tax benefit is also very often a key motivator for any founder who wishes to sell their business to an employee ownership trust (EOT).

Essentially under an EOT the entire share capital of a business are acquired, providing an exit for all shareholders on equal terms, financed out of future profits. But EOT’S are a complex issue and as with all such matters, good professional expert advice should always be taken, as individual circumstances can differ considerably.

Posted on by Mike Halls

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