Succession Planning – the importance of expert valuation when selling to an EOT
In the second of our new guest blogs, we ask Tom Lethaby, Business Development Manager of RVE Corporate Finance, why selling your company to an EOT could be the right approach for your succession planning – and how an expert valuation will ensure you agree a fair price.
Selling your business is likely to be the most important financial transaction you’ll ever undertake. It can be a stressful, costly and exhausting process which might not deliver the outcomes you had hoped for.
Since 2014 over 700 business owners have sold their companies to an Employee Ownership Trust (“EOT”). High profile examples of this sort of sale include Go-Ape (2021), TTP Group (2021), Richer Sounds (2019), Riverford Organic Farmers (2018) and Aardman Animations, the creators of Wallace and Gromit (2018). An EOT sale process tends to be a less stressful and less risky exit route for business owners - but it isn’t right for all types of businesses.
Managing your succession planning risk
An EOT is a low-risk transaction when compared to other types of exit process. It is essentially a form of share buyback, through which the shareholders of the company sell their shares to a newly formed EOT at a fair value, and the EOT pays off the purchase consideration using the historic and future profits of the company, which typically takes 5-8 years. In a sense, this is an internal transaction. The process isn’t reliant on any third-party buyer or bank, and the purchaser (the EOT) does not need to undertake extensive due diligence – the execution risk is therefore much reduced.
So how does the newly formed EOT decide what price to pay for the company it is buying?
The EOT is a trust which has a fiduciary duty to act in the best interests of the employees of the company. It is acting on their behalf to purchase the company from the existing owners. The Trustees (who typically comprise a mix of employees, independent professionals and perhaps also the company founder) must therefore pay a “fair” price and this is established through an independent valuation carried out by a corporate finance or accounting firm (such as RVE Corporate Finance “RVE”).
Agreeing a fair price for your business
There are several valuation methodologies used when assessing a company’s worth – generally either linked to profitability or revenue and occasionally linked to asset value.
Most EOT sales have been for small businesses, typically worth less than £20m (although the largest EOT deal on record was completed by our team at RVE last summer for £275m) and an EOT can be appropriate for businesses worth just £1m-£2m. To help guide valuations for these SMEs there are several organisations which provide M&A transaction data to corporate finance and accounting professionals. Transaction data is often segmented by company size and industry sector. Mark2Market, CMBOR and UK200 all regularly report both revenue and profitability multiples paid for SMEs – and it is the latter which would most commonly be used in assessing the value of a business for sale to an EOT.
When a company is sold to an EOT the objective is to create a perpetual partnership-style structure, similar to that used by the John Lewis Partnership - indeed the benefits of the “John Lewis Model” were heavily referred to by the Coalition Government at the time of the creation of the EOT legislation in 2014. An EOT allows employees, as shareholders through the trust, to benefit from the future stream of profit that the company will produce – dividends can be paid in the form of profit share bonuses to employees once the initial purchase consideration has been paid off (typically 5-8 years).
‘Although the largest EOT deal on record was completed in 2021 by our RVE team for £275m, most EOT sales are for businesses worth less than £20m – and the process can suit those worth just £1m to £2m’
Tom Lethaby, Business Development Manager, RVE
When RVE values a company for the purposes of an EOT sale, we produce a 10-year P&L forecast, with the company’s management, to model how profits will be allocated to pay down the purchase consideration and thereafter to pay profit share bonuses to employees. If the purchase consideration, based on a market value for the company, can only be paid down from profits over 10 years or more, then this is an indication either that the “market value” is too high for this particular company, or that the company is not well suited to the EOT structure (because it cannot generate cashflow to pay a reasonable purchase consideration within an acceptable timeframe).
Companies are typically valued on a debt free/cash free basis but retaining enough working capital for the business to fund its ongoing trading activities. If the company holds significant surplus assets, beyond what is needed for working capital, (e.g. surplus cash) then the value of these assets will be added to the debt free / cash free value to arrive at the fair value of the company. Surplus cash in the company can be used by the EOT to fund an initial “Day 1” pay down of the purchase consideration.
Claiming shareholder tax relief as an EOT
With any EOT sale shareholders will need to be patient, as the Company’s future profits are typically the only source of funds available to the EOT to fund the purchase consideration. It will take several years for the purchase consideration to be fully paid down and during this time shareholders will be holding a credit risk. Offsetting this risk however are tax reliefs that the shareholders can claim - HMRC grants a special 0% rate of Capital Gains Tax for shareholders selling to an EOT (“EOT Relief”) - saving shareholders typically between 10% and 20% of the proceeds that would otherwise be payable in CGT. The UK Government introduced EOT Relief in 2014 and remains highly supportive of Employee Ownership. Through EOT Relief the government is encouraging the sector to grow, as businesses that are owned by their staff are proven to be more productive and more resilient.
What should you do next?
In summary, we at RVE believe that all businesses owners should consider an EOT as part of their exit plans because it will deliver:
Competitive market-rate pricing for the shareholders
A sale process that is not driven by external parties
A sale which preserves the business as an independent entity, with its reputation and team intact
A significant saving in CGT
RVE Corporate Finance specialises in advising and structuring employee buyouts, where business owners sell their business to a newly-formed EOT.
Discover how we could support you to choose this option as part of your succession planning by contacting us info@rvecf.com.