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The pros and cons of employee ownership trusts

Interest in employee ownership is growing. Gerry Young and Tom Lethaby of RVE Corporate Finance, specialist advisers on employee ownership trust deals, talk about their experience of EOTs and the implications for CGT and M&A

The employee ownership model for UK companies has changed drastically in recent years – and it has been even more dramatic since the global pandemic began disrupting businesses last year. COVID-19 will have raised existential questions in the minds of many owner-managers. For those who have decided to move on, selling to an employee ownership trust (EOT) will be an option on the table – one that an increasing number of companies decide to take.

According to analysis by the Employee Ownership Association (EOA), the segment saw unprecedented growth in 2020 and this has continued. As of June 2021, there were 730 UK EOT-owned businesses, with more than 250 established over the previous 18 months.

Setting up shop

In March 2019, Gerry Young co-founded RVE Corporate Finance with former PwC colleague Mark Butler, in order to realise value for business owners through employee ownership.

Young’s journey began in 2015, when he left PwC after 25 years of advising on mid-market M&A. He had undertaken two spells at the Big Four firm, with five years at Schroders (now Citi) in between. He went solo, advising small companies, including owner-managed businesses, on exits: “What became clear to me was that the small-company segment of the market was being poorly advised on what was a very attractive form of exit – selling your business to an employee-owned trust.”

That process involves the outgoing owner selling the majority of their stake so that the company’s shares are held in a trust for the benefit of its employees.

The vendor is paid out of the future cash flows of the EOT-owned business. One of the key benefits and drivers for the owner-manager is that 0% capital gains tax (CGT) is payable on the sale of the shares to the EOT. Obviously, owning shares through a trust and the dividends that will flow from that is a big benefit for employees. But they can also be paid annual tax-free bonuses of up to £3,600 from an employee-owned business.

Young advised on several EOTs, before teaming up with his former PwC corporate finance colleague Butler to set up RVE. Young and Butler both trained as ACAs, and RVE is a member of the Corporate Finance Faculty. They were joined by experienced corporate and M&A lawyer Elaine Marriner as general counsel. She had previously worked for Morgan Crucible, HMV and Page Group. Then in May this year, Tom Lethaby joined RVE as business development director, bringing 20 years of experience working with SMEs in the drinks trade.

Many benefits

“The advantages for SME owners of EOTs have now become apparent,” says Young. “We’re a corporate finance adviser that structures the deal, values the business, obtains tax clearance from HMRC, does the legal work and then provides a trustee. Because of our focus and our unique offering, we’ve been very busy.”

Last year might have been a tumultuous one, but the firm completed seven sales to EOTs. Young expects it to complete a further 10 before the end of 2021, with a much higher average deal size than last year.

Most recently RVE advised TTP Group, a Cambridge-based technology consultancy, on a transition to EOT ownership. Started in the late 1980s, TTP Group has more than 300 employees. The transaction completed in August, and involved an offer being made by the EOT valuing TTP Group at £276m. Young believes this is the largest EOT transaction undertaken to date.

Young and Butler met the TTP chairman, Peter Taylor, at an EOA seminar in late 2019: “He explained some of the complexities of their particular situation. RVE then did a feasibility study, to look at it in more detail and how we might solve the share ownership issues.”

Another large recent transaction was the sale in March of London-based Vibe Teacher Recruitment. “The EOT solution fitted perfectly with the objectives of the founder owners”.

According to Young: “Lockdown emphasised to many the benefits of having an EOT structure. An increased level of uncertainty was introduced to M&A that probably made some deals fall over, as trade and financial purchasers withdrew due to valuation and funding uncertainty. However, an EOT purchaser is not reliant on external financing and can take a long-term view on valuation. So our EOT deals in 2020 completed where they perhaps would not had they been trade or private equity sales.”

Weathering the storms

The often rumoured, but as yet undelivered, increases in CGT rates in the UK also increased the demand for exits to EOTs in the run-up to the end of March 2021. About 4% of UK GDP is generated by employee-owned companies, according to EOA analysis. The EOA also claims that such companies have weathered the COVID-19 crisis better than many others, reporting that 60% of those businesses still managed to pay a dividend to their employee owners last year. “I’d say that is down to the engagement factor, which is what employee ownership really drives,” says Young.

Lethaby adds: “Long term, I think employee ownership will be just a normal part of the discussion with the vendor of a business, to be considered alongside an exit to trade or private equity. If we look at the number of UK companies out there with 20-300 employees as being potential targets for employee ownership, there are tens of thousands.”

One of the challenges is how an EOT-owned business accommodates future M&A. Young explains: “Acquisitions need to be funded by cash or debt because new share issues are very difficult within the EOT structure. It is also difficult when paying off vendor shareholders to make room for additional funding for acquisitions. Therefore, a buy-and-build strategy is better suited to private equity ownership. In many cases, particularly for professional services firms, a sale to private equity will not be an option. The EOT structure is particularly suited to businesses that don’t require heavy capital investment.”

Lethaby adds: “More than half of EOT businesses are professional services firms – architects, quantity surveyors and so on. But, increasingly, we see manufacturing, construction and healthcare businesses looking at EOT exits.”

The EOT sector is beginning to develop some momentum, says Young. “Some owners are initially attracted by the tax savings, but they are also attracted to the longer-term benefits of enfranchising their employees and the flexibility that EOTs offer in structuring an exit.” Young is confident therefore that EOT exits will soon become a mainstream option for SMEs.