Employee Ownership Trusts (“EOTs”) – What should trustees do if an offer is made for the company?
The EOT legislation is now 10 years old. Some EOT businesses may have reached “Financial Freedom Day”, paid off their founders and are considering the future, other EOT businesses may still be paying off the founder loans. In each case, the company may receive an unsolicited offer for the business. The trustees will have to consider their role and responsibilities on receipt of an offer rather than giving a flat “No Thank You” reply.
The unexpected offer
Most successful businesses can expect to receive an unsolicited offer, particularly with the large number of business news outlets that publish the results of companies even where the companies themselves want to carry on under the radar. The offer is likely to come to the desk or inbox of the managing director. The MD should have a very good idea of the likely value of the company and can filter out the lowball offers. However, the MD probably has a duty to pass on any viable offers to the shareholders; the EOT trust, for their consideration.
The MD may have a view on the offer; is the price about right? Is the buyer a good fit from a business and, probably more importantly, a cultural point of view? Do they look after their staff?
The trustee decision making
The first point for the trustees to check is who has the final say on the sale? The EOT deed should hold the answer and provide that the decision is made by the trustees, or the decision is passed to the employees (or more likely the eligible employees who have the minimum length of service). Even if the final decision rests with the employees, the trustees still need to satisfy their fiduciary duties in reaching a decision that the sale of the shares is in the best interests of the beneficiaries.
The trustees will have to consider similar issues to the MD although possibly concentrate more on the impact on the employees. Here are a list of points to consider:
- Price – is the offer price suitable? Do you have a recent valuation? Does the offer need testing in the market? If you test the market, do check the terms and conditions of the corporate finance adviser so you do not have to pay a huge fee on the successful sale to the company that made the offer in the first place.
- Cash to the employees – does the offer result in money being paid to the employees and is it enough? You need to ensure that the offer is not swallowed up by the tax payable on breaking the trust (see our article on the tax consequences of a sale), the payment of any remaining deferred consideration and the professional costs of the transaction.
- Impact on the employees – will the employees retain their jobs or does the buyer already have an established business with all the support functions so does not need your HR, Finance and back office teams? What is the likely career progression for employees?
- Cultural fit – does the buyer share the same “employees at the centre” culture? The EOT may have been established to protect the business culture. This may be the hardest part of the decision-making process. The buyer may be willing to promise the earth with very few guarantees that the promises will be met once the deal is done.
- Founders’ push – if the founders have not been paid their deferred consideration, they may be pushing for the acceptance of the offer as the sale will accelerate the receipt of their deferred consideration (all received tax-free). Trustees need to be aware of conflicts of interest – can the founder (if a trustee) take part in the decision-making process?
- Independent advice – do the trustees need independent legal advice, particularly if there are minority shareholders (usually former founders and senior management team) selling to the buyer?
There are a few issues to consider in the transaction itself:
- Payments to former employees – when a payment is made after a breach of the EOT, any employee who was a beneficiary and has left employment in the two years prior to the sale is entitled to a payment from the trust. The “equality treatment” applies on the same basis as if they were still employees. Can you find these employees? You could consider “workarounds” but these add to the complexity of the transaction for the seller and the buyer.
- Tax treatment of payments – the payments to employees are treated in the same way as a cash bonus, so subject to income tax and National Insurance Contributions (“NICs”). The income tax and employee NICs can be deducted from the cash payment. However, the EOT is not the employer and so the employer NICs are a cost to the employing company. How are you going to fund this liability with a payment from the buyer?
- Retention of money to pay the CGT due from the Trust – the trustees need to make sure money to pay the tax on breach of the trust is ring-fenced to pay the tax liability which may not be due to HMRC for some time. It may need to set up its own bank account (if it does not already have an account) to hold the monies required to pay the tax.
- Warranties and indemnities – the buyer may want protection for what they are buying in the form of warranties and indemnities about the business. The trust cannot give warranties as it will not have any cash after paying the tax and distributing the proceeds to the beneficiaries. If the founders are selling a minority shareholding, they may be able to give some warranties and indemnities. The buyer may have to rely on warranty and indemnity insurance with an agreement as to who pays the premium.
We acted on three EOT disposals in 2023 and each transaction brought up new issues to consider. The addition of the EOT brings an added layer of complexity to what can already be a complicated transaction. A buyer (and their advisers) who does not understand an EOT will result in a much more protracted transaction.
Craig Watters, Chief Operating Officer and a trustee director of 4most ESOT Limited, commented:
“Geldards provided support to the Trustees during the transaction, bringing a blend of tax, corporate and trust law experience to the table. They helped ensure the trustees met their obligations through a complex transaction offering a professional, personable and pragmatic approach.”
Sam Garrity, trustee director of Rocketmill EOT said:
“The assistance we received as trustees from Geldards was invaluable in completing the sale.”
If you would like to discuss the issues raised in this article, either as a recipient of an offer or as a prospective buyer of an EOT-owned business, please get in touch with either Andrew Evans or Debra Martin.