Are EOTs the new exit route?

Could your future be in your employee’s hands?

Specialist demolition and decontamination company, McGee, has recently announced it is now indirectly owned by its employees. This was achieved using an employee ownership trust (EOT) structure. An EOT has lots of advantages for both employees as well as selling shareholders. For sellers, for example, an EOT structure can result in zero rates of capital gains tax.

In this article Smith & Williamson’s Corporate Finance team in London explores:

• why might this trend be happening;
• whether the changing tax landscape such as the reduction in the availability of Entrepreneurs Relief, coupled with the availability of zero capital gains tax rates under an EOT structure, increases the likelihood of more sales to employees; and
• does the current economic climate, including the effects of COVID-19, enhance the opportunity?

Our research, combined with the conversations we have had with clients, highlight the benefits that an employee ownership structure has for the business, the employees and the owners.

For the Business and its Employees

Employee-owned company structures can enable a smooth ownership transition process, minimising business disruption whilst protecting the culture and ethos of the business.

The right structure can allow owners to reward long term loyalty and incentivise employees to grow the business post transition. It can also enable employees to take a significantly larger holding than they would otherwise be able to afford to, as their shareholding is paid for by the future cash flows of the business.

For the Business Owners

In contrast to a traditional sale process, a sale to employees avoids the need to disclose confidential information, such as key contracts and customer lists, to competitors. The existing management team can continue to run the business post transition, if appropriate, or changes can be made immediately or over an agreed period.

A sale to the employees can also be speedier and cheaper than alternative exit strategies, especially if external third-party funding is not required. In addition, as employees understand the day to day business operations, it can potentially eliminate disagreements over financial policies. For example, in a traditional M&A process, we spend a significant amount of time discussing the policies around WIP recognition to avoid impacting value.

With the introduction of new tax legislation, which has reduced the entrepreneurs’ relief lifetime limit from £10m to £1m, the attractiveness of being able to achieve a zero-capital gain tax rate if structured correctly is clear.

A Dream Solution?

There are several key points to consider when deciding whether a sale to employees is right for you. For example, compared to a trade sale, the amount of funds paid to the owners on day one can be less. The transaction is generally structured with payment to the owners from future earnings of the company over a period of time, although debt or excess cash can also be used to enhance upfront payments. In addition, the purchase price may not include any additional benefits realised from synergies created by operational efficiencies that an external buyer may pay for. Overall valuation expectations may need to be realistic.

What about the Current Trading Climate?

The uncertainty over the current trading environment suggests that deals structured with a higher element of deferred consideration are more likely. As a result, it could be that we will see an increasing number of deals of this nature as business owners seek to lock in both value and tax rates.

There is also considerable uncertainty about post-COVID tax policy. It is not impossible that the tax relief on sale to EOTs could be restricted or even withdrawn in the future. In consequence, business owners may want to think about their options in the short-term while the relief remains available. If you are considering an exit please talk to us to see if an EOT, or an alternative structure, would suit you.

How can Smith & Williamson help?

Please contact our team who can support you with:

• Advice on the exit routes available to you;
• Structuring the transaction including valuation advice;
• Cash flow modelling;
• Tax planning, including EOT advice;
• Advice on the accounting treatment of the transaction; and
• Bonus planning and share schemes advice post-sale.

For further information or if you would like to discuss your specific circumstances, please contact:

Brian Livingston
Managing Director, Corporate Finance
T: 020 7131 4914
E: brian.livingston@smithandwilliamson.com

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Notes to editors
Smith & Williamson is a leading financial and professional services firm providing a comprehensive range of investment management, tax, financial advisory and accountancy services to private clients and their business interests. The firm’s c1,800 people operate from a network of 11 offices: London, Belfast, Birmingham, Bristol, Dublin (City and Sandyford), Glasgow, Guildford, Jersey, Salisbury and Southampton. Smith & Williamson is part of The Tilney Smith & Williamson Group.

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