Employee ownership trust problems

In this article, we are going to outline some of the problems that might arise if the transition to employee ownership is not managed and advised on correctly.

Valuation of the company

When selling your business to an EOT it is very important that you keep the valuation realistic. Often the consideration will be paid out of existing cash in the business on day one, with a level of consideration left outstanding and payable to the exiting shareholders over time out of future profits, known as “deferred consideration”.

An inflated price/valuation of the business may place undue stress on the business to repay the deferred consideration and may limit the amount of employee engagement and harm motivation among the employees.

Recoverability of deferred consideration

There is also a risk on any selling shareholder over the recoverability of deferred consideration as this is dependent on the performance and cash availability of the business. If the business underperforms, there is a risk that the deferred consideration may be delayed. This is another reason why it can be detrimental to selling shareholders if the valuation of their business when selling to an EOT is inflated.

At Hawsons, our experts can provide you with an independent valuation of your company to ensure that it is fair and reasonable. As expert EOT advisers, Hawsons would work with you to design a bespoke deferred consideration payment plan, using future cash flow projections, ensuring the business has cash headroom to perform, and helping limit the risk of non-payment.

Getting disqualified

It is important, for the exiting shareholders, that the EOT rules are adhered to, as disqualifying events can lead to adverse tax consequences. If a disqualifying event occurs (before the end of the tax year following the tax year in which the disposal occurred) then the seller is liable for Capital Gains Tax. After this period, the CGT burden passes to the trustees of the EOT.

Disqualifying events include the following:

• The company ceases trading.
• The EOT no longer meets all of the employee benefit requirements or controlling interest requirements.
• There is a breach of the limited participation requirement.
• The trustees are not following the employee equality rules.

At Hawsons our EOT experts will ensure that your EOT is set up to mitigate the risk of these disqualifying criteria to allow peace of mind for the exiting shareholders and employees alike.

Conclusion

Whilst there are potential pitfalls associated with an EOT disposal, when suitably structured and advised on, these can mostly be mitigated through sound professional advice from an experienced EOT advisor.

Find out more about EOTs and our EOT advisors.

Pete leads the Corporate Finance offering across the firm, having has spent much of his career within a large international accountancy firm and corporate banking before returning to Hawsons, where he started. Working with businesses of all sizes, Pete has an exceptional breadth of experience which he brings to the benefit of clients.

An early adopter and passionate believer in good employee ownership, Pete has helped numerous businesses transition to employee ownership and works extensively to promote the employee ownership model.