These days, when business owners consider their options for exit, selling to an EOT (Employee Owned Trust), is frequently on the list.
There are excellent reasons for this. The headline reason is that that on sale to an EOT, no Capital Gains Tax (CGT) is due. This is a hugely valuable incentive for exiting shareholders, and one which looks to become more valuable as the rate of CGT on sale of business assets increases.
According to the consultation on EOTs which the Government launched in 2023 and which has yet to be concluded upon, the objectives of the incentive are “rewarding employees and encouraging employee engagement”. Surely then, the sale of a business to an EOT is a win: win with the vendor benefiting from reduced taxation and the employees gaining the benefits and mindset of business ownership. Presumably the expectation is that with skin in the game employees will be more driven, productive and entrepreneurial.
The potential upsides are clear. But what do employees actually get if the business they work in is sold to an EOT ? The principle benefit is that the EOT is allowed to pay employees a tax free bonus of £3,600 a year. The value of this bonus has been fixed since 2014 and the amount has to be applied consistently across the whole cohort of employees regardless of seniority. It is possible to vary bonuses by reference to relative hours worked, salary and length of service but it is not possible to use them to mark contribution or achievement.
The EOT will be governed by a board of trustees. At the moment, the vendor of the shares can be a trustee but under the current consultation it is proposed that this should no longer be the case. The key criteria for trusteeship is independence and the EOT has to lead the business in the interest of all the employees.
The terms of a sale to an EOT are usually that an initial up front payment will be made for the shares, funded frequently by cash or assets on the balance sheet. The balance of consideration is usually deferred, made up of a loan due from the EOT to the vendor(s). This loan has to be paid down before the EOT members (employees) benefit from the value of the business the trust now owns. Depending on the valuation at which the initial sale to the EOT has been transacted, the period over which debt needs to be paid can be a number of years.
The benefits of share ownership in an EOT other than the annual tax free bonus, are negligible unless there is some expectation that the business will ultimately be sold such that the employees benefit from a capital gain/lump sum. The tax rules associated with EOTs are designed to disincentivise this however. It is clearly HMRCs intent that EOTS should retain the shares in perpetuity and run the business for the benefit of the employees.
If the shares in the business are sold by the EOT to a third party within two years of the initial deal then the original vendor has to pay the Capital Gains Tax which would have been paid had their sale been to the same third party (ie the tax benefit is lost). If the sale of the business by the EOT is after two years then the EOT itself has to make good to HMRC the “lost” tax. Once any debt due to the original vendor is paid, and the legal and other costs of the deal are covered, and the tax accounted for to HMRC then any excess consideration can be distributed to the employees. The sting in the tail is that the distribution has to go through the payroll and is subject to normal payroll deductions (income tax and NI). Even for a sale at a valuation well in excess of the original deal, the benefit to an individual employee is unlikely to be life-changing.
As EOTs have matured over the last 10 years, more of them have looked to sell their shares and more of them have found just how the rules disincentivise this.
Essentially, when you sell your business to an EOT you are removing the entrepreneurial incentive which is typically the driving force that has led to business success in the first place. Once a business is in an EOT it is almost impossible for even the most effective business leader to be fully incentivised.
If the motivation for selling to an EOT is to realise, at zero tax, cash or assets locked in a business balance sheet then it makes sense. If the business can be confident of perpetual leadership that isn’t motivated by the opportunity for significant capital gain in the future, then that is probably ok. If it doesn’t matter hugely whether the business survives in the long term once its debt is paid down, then go for it.
But for previously owner managed businesses, used to the driving force of an individual or individuals, the shift into communal ownership, the loss of any meaningful prospect of a capital gain and modest annual tax incentives delinked from individual performance seems highly likely to tend towards moribundity and statis.
In a nutshell EOTs can be a brilliant outcome for vendors. But as time goes on it will be interesting to track the performance of mid market businesses under EOT ownership. The constantly cited example of John Lewis Partnership, with its £12.5bn revenues and 74000 employees, is able to invest fully in making the employee voice heard and paying an executive board healthy salaries and performance bonuses. Not so much a 100 employee business, paying down vendor loans, funding the costs of an independent trustee, funding the promised tax free bonuses for all employees regardless of their performance and without any meaningful equity stake to lure a top quality management team.
Accepting that the tax treatment is less favourable, the would-be vendors of entrepreneurial owner-managed businesses would do well to consider other options if they want their enterprises to thrive beyond their ownership.
Apart from finding a third party acquirer to buy the shares it is worth considering a sale to a motivated management team who will be able to benefit from the growth in value they deliver once any vendor loans have been paid off. There are a number of ways of funding the MBO of a mid market business, including private equity and third party debt (sourced either from a bank or a debt fund). A classic route for vendors who want to keep their business independent, are happy to receive their cash in tranches over time and trust their management team to deliver, is to fund the buy out themselves by means of vendor loan notes. Not as tax efficient as an MBO but with more control, more incentive for key management and with a greater ability to step back in if needed.
In short, business owners considering EOT as an exit route should ensure that they fully understand not only the initial implications but also those in the longer term. For some businesses an EOT can become a prison that ultimately limits their progress. There are other options for vendors and it is worth exploring them side by side with an EOT before making a decision.
These days, when business owners consider their options for exit, selling to an EOT (Employee Owned Trust), is frequently on the list.
There are excellent reasons for this. The headline reason is that that on sale to an EOT, no Capital Gains Tax (CGT) is due. This is a hugely valuable incentive for exiting shareholders, and one which looks to become more valuable as the rate of CGT on sale of business assets increases.
According to the consultation on EOTs which the Government launched in 2023 and which has yet to be concluded upon, the objectives of the incentive are “rewarding employees and encouraging employee engagement”. Surely then, the sale of a business to an EOT is a win: win with the vendor benefiting from reduced taxation and the employees gaining the benefits and mindset of business ownership. Presumably the expectation is that with skin in the game employees will be more driven, productive and entrepreneurial.
The potential upsides are clear. But what do employees actually get if the business they work in is sold to an EOT ? The principle benefit is that the EOT is allowed to pay employees a tax free bonus of £3,600 a year. The value of this bonus has been fixed since 2014 and the amount has to be applied consistently across the whole cohort of employees regardless of seniority. It is possible to vary bonuses by reference to relative hours worked, salary and length of service but it is not possible to use them to mark contribution or achievement.
The EOT will be governed by a board of trustees. At the moment, the vendor of the shares can be a trustee but under the current consultation it is proposed that this should no longer be the case. The key criteria for trusteeship is independence and the EOT has to lead the business in the interest of all the employees.
The terms of a sale to an EOT are usually that an initial up front payment will be made for the shares, funded frequently by cash or assets on the balance sheet. The balance of consideration is usually deferred, made up of a loan due from the EOT to the vendor(s). This loan has to be paid down before the EOT members (employees) benefit from the value of the business the trust now owns. Depending on the valuation at which the initial sale to the EOT has been transacted, the period over which debt needs to be paid can be a number of years.
The benefits of share ownership in an EOT other than the annual tax free bonus, are negligible unless there is some expectation that the business will ultimately be sold such that the employees benefit from a capital gain/lump sum. The tax rules associated with EOTs are designed to disincentivise this however. It is clearly HMRCs intent that EOTS should retain the shares in perpetuity and run the business for the benefit of the employees.
If the shares in the business are sold by the EOT to a third party within two years of the initial deal then the original vendor has to pay the Capital Gains Tax which would have been paid had their sale been to the same third party (ie the tax benefit is lost). If the sale of the business by the EOT is after two years then the EOT itself has to make good to HMRC the “lost” tax. Once any debt due to the original vendor is paid, and the legal and other costs of the deal are covered, and the tax accounted for to HMRC then any excess consideration can be distributed to the employees. The sting in the tail is that the distribution has to go through the payroll and is subject to normal payroll deductions (income tax and NI). Even for a sale at a valuation well in excess of the original deal, the benefit to an individual employee is unlikely to be life-changing.
As EOTs have matured over the last 10 years, more of them have looked to sell their shares and more of them have found just how the rules disincentivise this.
Essentially, when you sell your business to an EOT you are removing the entrepreneurial incentive which is typically the driving force that has led to business success in the first place. Once a business is in an EOT it is almost impossible for even the most effective business leader to be fully incentivised.
If the motivation for selling to an EOT is to realise, at zero tax, cash or assets locked in a business balance sheet then it makes sense. If the business can be confident of perpetual leadership that isn’t motivated by the opportunity for significant capital gain in the future, then that is probably ok. If it doesn’t matter hugely whether the business survives in the long term once its debt is paid down, then go for it.
But for previously owner managed businesses, used to the driving force of an individual or individuals, the shift into communal ownership, the loss of any meaningful prospect of a capital gain and modest annual tax incentives delinked from individual performance seems highly likely to tend towards moribundity and statis.
In a nutshell EOTs can be a brilliant outcome for vendors. But as time goes on it will be interesting to track the performance of mid market businesses under EOT ownership. The constantly cited example of John Lewis Partnership, with its £12.5bn revenues and 74000 employees, is able to invest fully in making the employee voice heard and paying an executive board healthy salaries and performance bonuses. Not so much a 100 employee business, paying down vendor loans, funding the costs of an independent trustee, funding the promised tax free bonuses for all employees regardless of their performance and without any meaningful equity stake to lure a top quality management team.
Accepting that the tax treatment is less favourable, the would-be vendors of entrepreneurial owner-managed businesses would do well to consider other options if they want their enterprises to thrive beyond their ownership.
Apart from finding a third party acquirer to buy the shares it is worth considering a sale to a motivated management team who will be able to benefit from the growth in value they deliver once any vendor loans have been paid off. There are a number of ways of funding the MBO of a mid market business, including private equity and third party debt (sourced either from a bank or a debt fund). A classic route for vendors who want to keep their business independent, are happy to receive their cash in tranches over time and trust their management team to deliver, is to fund the buy out themselves by means of vendor loan notes. Not as tax efficient as an MBO but with more control, more incentive for key management and with a greater ability to step back in if needed.
In short, business owners considering EOT as an exit route should ensure that they fully understand not only the initial implications but also those in the longer term. For some businesses an EOT can become a prison that ultimately limits their progress. There are other options for vendors and it is worth exploring them side by side with an EOT before making a decision.
Refinancing existing debt can unlock significant benefits for borrowers, including lower interest costs, increased financial flexibility, and the consolidation of existing debt facilities. However, given the complexity of today’s debt market and the infrequency of refinancing transactions (typically completed every 4–5 years), borrowers must approach the process strategically to secure optimal terms. Below, we highlight the key considerations for a successful refinancing and how HMT can assist.
Define Clear Financing Objectives
Every refinancing process has a unique set of financing objectives, whether it’s optimising pricing, consolidating debt, securing additional headroom in covenants, or unlocking debt capacity for acquisitions. These objectives can be overshadowed by time pressure or the complexity of involving multiple lenders in the process. To ensure the best possible outcome, it’s crucial to remain focused on those objectives and prioritise them clearly. This prioritisation, will serve as a guiding framework, shaping decision-making and negotiation strategy throughout the process.
Select the Right Lenders
To align with the financing objectives, selecting the right group of lenders is crucial. For straightforward refinancing needs, a combination of traditional high-street lenders and challenger banks is often sufficient. However, when addressing more complex financing challenges, such as bridging funding gaps or supporting growth, it’s advisable to approach lenders with a higher risk appetite and alternative lending criteria. For instance, asset-based lenders or those focused on recurring revenue can help unlock additional debt capacity from the balance sheet or revenue streams. Additionally, unitranche and mezzanine lenders may be more comfortable providing financing at higher leverage levels, making them suitable for maximising debt capacity.
The current debt market offers more options than ever but navigating this landscape can be challenging for borrowers with limited refinancing experience. A trusted advisor with up-to-date insights into lender preferences and recent transactions can provide invaluable guidance in identifying and engaging the right lender pool.
Timing is Crucial
Refinancing plans should begin ideally two years before the debt matures. Auditors require a 12-month “going concern” horizon from the signing of financial statements, necessitating early preparation. Prolonged processes that slip closer the maturity date can inadvertently strengthen the position of incumbent lenders, who may leverage reduced competition to offer less favourable terms.
Additionally, lenders’ internal credit processes are subject to more scrutiny and therefore demand more time and information, further highlighting the importance of early action.
Prepare a Strong Information Package
A tailored information package is the cornerstone of any successful debt process. This package should include a management presentation that covers the business’ strategic plans for the next 3–5 years and address lenders’ key credit focus areas. Lenders are more risk-averse than the board of directors / equity investors, so the messaging must balance growth ambitions with a clear demonstration of risk mitigation strategies. Lenders also need to meet with management to provide confidence that the executive team has the experience and capability to run the business on a day-to-day basis.
Given recent market dynamics, it’s also vital to address issues such as, for example, cost inflation upfront. In that example, proactively showcasing how inflationary pressures have been managed can enhance lender confidence.
How HMT Can Help
HMT is a boutique corporate finance firm specialising in advising entrepreneurial businesses. With over 10 years of experience in debt advisory, we help clients position themselves strategically from a credit perspective, ensuring they attract the right lenders and secure optimal terms.
To give recent examples, we advised the AIM-listed ASIC designer and supplier EnSilica on a refinancing that replaced its existing debt structure with more flexible facilities, reducing interest costs and unlocking greater financial flexibility. We also advised fulfilment solutions provider, Diamond Logistics, on their multi-million pound fundraise with growth capital provider Frontier Development Capital.
If you’re considering refinancing, HMT can guide you through the process from planning to execution to achieve your financing goals. Reach out to learn if you’d like to have a conversation and learn more about how we can help.
Refinancing existing debt can unlock significant benefits for borrowers, including lower interest costs, increased financial flexibility, and the consolidation of existing debt facilities. However, given the complexity of today’s debt market and the infrequency of refinancing transactions (typically completed every 4–5 years), borrowers must approach the process strategically to secure optimal terms. Below, we highlight the key considerations for a successful refinancing and how HMT can assist.
Define Clear Financing Objectives
Every refinancing process has a unique set of financing objectives, whether it’s optimising pricing, consolidating debt, securing additional headroom in covenants, or unlocking debt capacity for acquisitions. These objectives can be overshadowed by time pressure or the complexity of involving multiple lenders in the process. To ensure the best possible outcome, it’s crucial to remain focused on those objectives and prioritise them clearly. This prioritisation, will serve as a guiding framework, shaping decision-making and negotiation strategy throughout the process.
Select the Right Lenders
To align with the financing objectives, selecting the right group of lenders is crucial. For straightforward refinancing needs, a combination of traditional high-street lenders and challenger banks is often sufficient. However, when addressing more complex financing challenges, such as bridging funding gaps or supporting growth, it’s advisable to approach lenders with a higher risk appetite and alternative lending criteria. For instance, asset-based lenders or those focused on recurring revenue can help unlock additional debt capacity from the balance sheet or revenue streams. Additionally, unitranche and mezzanine lenders may be more comfortable providing financing at higher leverage levels, making them suitable for maximising debt capacity.
The current debt market offers more options than ever but navigating this landscape can be challenging for borrowers with limited refinancing experience. A trusted advisor with up-to-date insights into lender preferences and recent transactions can provide invaluable guidance in identifying and engaging the right lender pool.
Timing is Crucial
Refinancing plans should begin ideally two years before the debt matures. Auditors require a 12-month “going concern” horizon from the signing of financial statements, necessitating early preparation. Prolonged processes that slip closer the maturity date can inadvertently strengthen the position of incumbent lenders, who may leverage reduced competition to offer less favourable terms.
Additionally, lenders’ internal credit processes are subject to more scrutiny and therefore demand more time and information, further highlighting the importance of early action.
Prepare a Strong Information Package
A tailored information package is the cornerstone of any successful debt process. This package should include a management presentation that covers the business’ strategic plans for the next 3–5 years and address lenders’ key credit focus areas. Lenders are more risk-averse than the board of directors / equity investors, so the messaging must balance growth ambitions with a clear demonstration of risk mitigation strategies. Lenders also need to meet with management to provide confidence that the executive team has the experience and capability to run the business on a day-to-day basis.
Given recent market dynamics, it’s also vital to address issues such as, for example, cost inflation upfront. In that example, proactively showcasing how inflationary pressures have been managed can enhance lender confidence.
How HMT Can Help
HMT is a boutique corporate finance firm specialising in advising entrepreneurial businesses. With over 10 years of experience in debt advisory, we help clients position themselves strategically from a credit perspective, ensuring they attract the right lenders and secure optimal terms.
To give recent examples, we advised the AIM-listed ASIC designer and supplier EnSilica on a refinancing that replaced its existing debt structure with more flexible facilities, reducing interest costs and unlocking greater financial flexibility. We also advised fulfilment solutions provider, Diamond Logistics, on their multi-million pound fundraise with growth capital provider Frontier Development Capital.
If you’re considering refinancing, HMT can guide you through the process from planning to execution to achieve your financing goals. Reach out to learn if you’d like to have a conversation and learn more about how we can help.
