“An extra £10 million in the hands of the company founder…” were my concluding words after working through an example of a client who is currently reviewing their exit opportunities from the business they founded thirty years ago.
On the face of it, that sum would suggest a very high-value business, but in fact it wasn’t, it was a company, one of many hundreds in the south-west, which could quite easily command a trade value of £45 million.
In this case, the sole founder of the company had built a very successful business over many years. Modest dividends had been taken and a significant amount of excess cash remained (circa £5m) in the company. In our exploration of exit options (sale, family succession, MBO, venture capital etc) we touched on a sale to the employees. This was of clear interest and we considered it further.
We do this as a matter of course for three reasons. Firstly, many business owners express their affection and loyalty to the employees and want to make sure that they will do well once they have retired. Secondly, the process and the timing is all in the hands of the founder, meaning that it happens on their terms alone. Thirdly, we would almost certainly be negligent in not alerting them to the potential tax advantages of a sale to the employees through an employee buy out.
I set out below a very basic overview of a trade sale versus an employee buy out. Professional advisers will know that there is much more to both, but the fundamental points are relevant.
Trade sale of the company:
- The company agreed to be sold by way of a trade sale for £45m on a cash-free/debt-free basis.
- Free cash of £5m in the company increases the consideration payable to £50m.
- Under a thorough due diligence exercise, the buyer finds several issues to argue over and demands a price deduction. While some owners hold their nerve, many find themselves browbeaten into a compromise. At this value, a £2m deduction would not be unusual.
- Sale completes. Deduct £1m representing 10% CGT based on Entrepreneur’s Relief from first £10m.
- Balance of sale proceeds: £38m. Deduct £7.6m representing 20% CGT on balance.
- Total net sums received by Founder £39.4 million
Now that is a significant sum of money, but so is the £10.6 million paid to tax and knocked off the sale price. Compare that with a sale to an Employee Ownership Trust on behalf of the employees:
- The sale price of £50m inclusive of free cash (no need to find a buyer).
- Much lighter due diligence process – price is unlikely to be chipped unless valuation does not hold up. No price adjustment deduction.
- Sale to EOT completes. Initial payment of £5m is made utilising free cash in the company. No CGT payable.
- Balance of £45m payable over 10 years, £4.5m per year free from tax.
- Total net sums received by Founder £50 million.
There are, of course, multiple variations that play out in a deal process, and certainly, a good corporate finance team will often be able to enhance the sale price by identifying synergies for the Buyer which cannot be argued in an MBO or employee buy out. Furthermore, the founder will have to wait for their payments in a sale to an EOT, though earnouts, deferred payments and warranty claims can also delay payments in a trade sale.
An EOT will not be suitable for each and every business, but for many owners, it often reveals itself as the succession strategy that suits them best. It allows for legacy, secures the employees, takes a lot of heat out of the process and potentially releases more money.