Selling a business through an Employee Ownership Trust (EOT) is an excellent exit strategy for those shareholders who want to preserve the legacy of their company whilst realising wealth at 0% Capital Gains Tax. It can also be a soft exit for sellers who want to gradually relinquish control – but many, however, do not explore an EOT sale as they fear the complexity and the work involved in managing the Trust and business after a sale.
An EOT sale is not a complex process. Employee-owned businesses are normal limited companies run on commercial terms; the key difference is that the shares are owned by a trust for the benefit of all the employees. We use a new trust company, limited by guarantee, to purchase the ‘trade’ company, so it does not have shares nor shareholders and thereby protects the employees from liability. It also means that there is no direct ownership, enabling the comings and goings of employees without share transfers thus reducing future succession issues. The valuation will, to a certain extent, be dictated by the excess cash the business has at completion combined with the cashflow requirements forecasted over the coming years, please see our webinars and guides for further information.
Managing the business and the trust post-completion are areas that require greater understanding, and these aspects of employee ownership will be the focal point of this article. The three critical elements of an EOT succession are developing the management team, the role of the trustees, and employee communications.
The Management
Is the management prepared for the undertaking of running the business and if not, how can this be built?
Whilst the employees are the new stakeholders, their stake in the business might never be realised. For an EOT transaction to be effective, it is crucial that employees are compensated and rewarded in the form of a competitive compensation plan, bonuses, and other incentives. The role of the trustee board also needs to be clearly stated in terms of the decision-making processes they should be involved in.
The seller ‘may’ retain a management role following an EOT, however, the composition of the management board will and should change to reflect the change of control. As a result, it is crucial to audit roles and duties and analyse competencies to find any gaps. It may be necessary to enrol in training programmes to increase managerial skills and financial literacy and facilitate pay increases and promotions to the board to create alignment within the team prior to the sale. This is all vendor and advisor-led and does not need to be discussed with management until a final decision is made that an EOT is an optimal way to proceed. EOT sales do not require management sign-off, but they do need management alignment.
The Board of Trustees
Is the business for the benefit of the employees and professionally run to ensure any sale structure is paid?
EOTs are controlled by trust law, which stipulates that each trustee must be accountable for the assets and actions of the trust on behalf of its beneficiaries, in the same way as other forms of trusts, including charities, family and wills. The employees are the only beneficiaries in the case of EOTs and the trustees are primarily responsible for ensuring that an EOT is successful once it has been established. The board of trustees is typically comprised of:
- An employee trustee (they must be nominated)
- A professional trustee
- An ex-shareholder/seller
The trustee board will ideally have a minimum of three representatives to avoid deadlock and its responsibility is to represent the views and interests of the employees. In larger organisations (100 plus employees), the trustee board might co-exist with an employee council. Additionally, it will be the duty of the trustee board to see that any vendor loans (the customary way to cover the cost of the sale to the EOT and realise shareholder value) are repaid.
The Roles of Trustees
Are the employees engaged?
The trustees’ board needs somebody who can maintain alignment with all parties while understanding that the employees are the ones the EOT is there to serve. Acting as the lynchpin is the professional trustee who ensures that neither the selling shareholder’s nor the employee’s position is overrepresented – they present an independent balance of viewpoints. In this role, the trustee must focus on the following:
- Have the employees understood the purpose of the trust?
- Is the financial performance of the business aligned with the budget?
- Are the managers running the business in a way that is mindful of the benefit of the employees – although the trustees should avoid operational involvement?
- Meeting quarterly to review aspects, such as the cash flow being on track for both loan note gifts and employee bonuses. Is there good governance of the spending level?
- Holding at least, one annual general meeting (AGM) per annum to review the accounts and plans for the coming year and provide a decision on whether they support the annual business plan or not, as presented to them by the company board of directors.
- Ensuring that they are only presented with items for approval on an exception basis or at the decision of the specific trust – for example, if the business is not performing in accordance with the plan.
The responsibilities and priorities will vary depending on the nature, size and structure of the business, and the structure of the trust. It is, however, very clear that the trust board should avoid any operational mandate.
The Employees
Have the employees understood, the new ownership structure and are they gently being engaged more with some additional benefits from the start? How can these benefits be built over time?
The trustees and management team must explain the extent to which the employees are now involved in the trust and, consequently, the business. This includes the understanding that they do not personally own any percentage of the company (unless a hybrid model has been used with some direct management holding).
Since there is no favoured owner, all employees labour for the benefit of all, regardless of share certificates, this is a crucial point because, despite what many people may believe, there is little proof that employee-owned businesses are ever resold. The debt structure that goes with a sale may be viewed negatively by management but in fact, nearly all trade deals require debt structures.
Summary
With 0% capital gains tax, and a slow transition over time to the team, vendor-led and often values greater than an MBO or trade sale make an EOT an attractive sale option.
Whilst EOT transition may appear complex, in reality, a slow approach to change always pays. The commercial business model must sit centre stage and the three governance areas of the trustee, management board and employees all have very straightforward roles within the model which can be built over time. This makes an Employee Ownership Trust a highly realisable, straightforward, and therefore accessible exit strategy for many owner-managed businesses with an eye on succession and a sale. The tax breaks can, in many instances, result in a value that is higher than could be secured through a trade sale with the sellers stepping back over time, which can be less of a shock than immediate retirement. Deal structure and the legal complexities of trusts are also straightforward with the right advisory team.
Contact Avondale Corporate
Avondale is a leading business advisor that helps ambitious owners realise value through employee ownership sales and transition. These are typically vendor-led sales structured over time to realise the value of the business and reward and empower the team. We are the only advisor providing a turn-key solution that covers legal, financial, trustees, and consulting. This means we deliver the right structure with 0% Capital Gains Tax and work with you and your team to ensure that the new business structure works post-completion.
If you are looking for advice or an exploratory discussion without obligation please contact us at +44 (0)1737 240888, our Contact Us page, or email av@avondale.co.uk and together we can examine your opportunities.
