Selling to an EOT is a great succession plan for many entrepreneurs, but getting a fair price is critical to maximising all your hard work. This guide covers the core questions every entrepreneur should ask before committing to a purchase.
Employee Ownership Trusts (EOTs) are growing in the UK, with the idea of employees owning the businesses they work for becoming more attractive. It’s estimated that in the last decade, the number of EOTs has tripled in the UK.
Like any business transaction, value is everything. Selling to an EOT is a great succession plan for many entrepreneurs, but getting a fair price is critical to maximising all your hard work. The valuation procedure can be complicated for EOTs, so this guide covers the core questions every entrepreneur should ask before committing to a purchase.
Understanding Employee Ownership Trusts (EOTs)
EOTs are trusts that allow employees to own a company indirectly. The company’s existing owners might set them up as they prepare their exit strategies. Initially created by the Finance Act 2014, they have gradually grown in popularity.
Usually, EOTs will agree on a price based on an independent assessment of a company. The caveat is that the price cannot be more than the fair market value, and the payments are made in instalments. The EOTs themselves are funded through the company’s future profits. As of July 2024, 1,756 UK companies are now EOTs, comprising 124,000 employees.
How is a company valued for an Employee Ownership Trust?
The two cornerstones of a transaction involving an EOT are that the valuation must not exceed fair market value, and an independent party must conduct the valuation. In other words, the owners can’t arbitrarily pluck a number from thin air.
EOT valuations are designed to protect both owners and employees. They ensure that owners gain a fair reward for their hard work, whereas employees are protected so that they gain fair value from future company profits.
So, what aspects will a valuation examine?
It’s also not uncommon for business owners to commission multiple independent valuations to find a fair figure. Business valuation isn’t an exact science, so working with several experts can provide additional clarity for arriving at a reasonable valuation for your firm.
Learn More about EOTs with our Team
What to ask in an Employee Ownership Trust valuation
Are you selling to an EOT? Typically, these are non-adversarial transactions because you’re selling to a party you already know. But that doesn’t mean you want to leave money on the table. You spent years of hard work building your business, and now is the time to reap the rewards.
Here’s a rundown of the top five questions to ask as part of these valuations.
How much surplus is in the business?
Selling to an EOT means you receive 100% capital gains tax relief. The value of any business must factor in any surplus cash already in the business that’s due to you as part of the sale. It’s an enormous consideration because if you opted for an ordinary M&A transaction, you’d be forced to take this cash as a taxable dividend.
Likewise, the business must be profitable in the years ahead to fulfil all future payments as part of the sale. That’s why you must balance that initial payment with the future operation of the company.
How profitable is the business?
Most EOTs are paid for by making an initial cash payment to the outgoing owner, with everything else deferred over the next few years. These payments are then covered by future post-tax profits.
Any valuation must factor in the company’s ability to maintain a minimum level of profitability in the years to come.
How long will I wait for the balance to be met?
How you structure the transaction impacts when the outgoing owner receives the full payout for selling their company to an EOT. The full payout normally takes five to seven years, but it can take longer.
Calculate how long it will take for the entire balance to be paid. For example, if it’s expected to take more than a decade, the chances are you’ve overvalued the company.
Does the valuation align with the HMRC definition of “fair market value”?
All valuations must meet the definition of fair market value because of the tax relief associated with selling your company to an EOT. Since you can’t agree on a figure with HMRC in advance, getting the valuation right the first time is critical, or there could be significant tax penalties later.
That’s why you must have a valuation backed by a mountain of evidence at the time. Stay on the safe side by assuming you might have to defend the valuation later.
What are the costs of my succession plan?
EOTs have risks attached to them because once you sell, you’re not able to achieve a clean break until the outstanding balance is fully paid off. That means a fair valuation must reflect the realities of the economy and your industry.
For example, if the business underperforms after completing your EOT, there may need to be adjustments to the repayment terms. Consider how this might impact your situation. Likewise, think about what role, if any, you’ll still have in the business. Some former owners remain in management, meaning they must have a compensation package that’s justifiable and doesn’t impact the company’s ability to operate.
Consider what your succession plan could mean and how it matches up with the final valuation. It’s a tricky balance to get right, and getting it wrong could have significant implications for the business you leave behind and potential HMRC compliance.
We understand how complicated this can get, which is why enlisting the services of a professional valuation agent is invaluable. At Hilton Smythe, we leverage our robust network of experts to support EOT transactions, regardless of where you are in the process. To learn more, speak to the team today.