Employee ownership, through selling your company to an EOT, is one option that might be considered as part of business ownership succession planning. An independent valuation of the business is required when an EOT acquires a majority stake in a company, but what are some of the valuation issues in this type of transaction?
What type of valuation’s needed?
There are several commercial and tax considerations involved in the sale of a majority stake to an EOT, so it’s important to obtain professional advice. One of the key factors is producing a robust tax valuation of the holding being acquired by the EOT. Where banks are involved, some lenders will also require an independent commercial valuation. The two can sometimes be produced as part of the same exercise, but there can be differences in approach and conclusions depending on the basis of value assumed in the commercial valuation.
How does a tax market value compare to a sale to trade or private equity?
The tax valuation aims to arrive at the ‘market value’ of the shareholding being acquired by the EOT, defined in UK tax legislation as ’the price which those assets might reasonably be expected to fetch on a sale in the open market’.
Where a business has been marketed and not found a buyer, there could be a downward impact on the tax market value since a notional transaction has to be assumed to take place at the valuation date. A lack of appetite at the ‘marketed price’ can only suggest that, were a transaction to be assumed to take place at that date, it would be at a lower value.
A multiple of profit is often used to derive a business valuation. This is on the premise that a buyer would be willing to pay for a certain number of years’ profit in return for expected additional returns, or the possibility of the business outperforming expectations, amongst other factors. Since a major part of the payment in a sale to an EOT is often settled out of future profits, an excessively high multiple may mean that the EOT will be paying for the acquisition for many years to come, which is likely to be undesirable for both the employees and vendors.
So an EOT exit shouldn’t be seen as an easy way to achieve a ‘desired’ price; and concluded tax market values may be lower than a vendor might be hoping to achieve in a competitive bidding process.
Another point to note on tax market value is that a sale to an EOT of less than 75% of the equity is likely to attract a discount to ‘pro rata value’.
Some good news
The flip side is that, where there’s an appetite for employees to become owners of the business, an EOT exit does create certainty of a transaction with more familiar ‘friendly’ buyers. And, from an economic perspective, the tax benefits to vendors of an EOT sale can more than counter any reduction in headline value.
When combined with the well-documented benefits of employee ownership as a means of engaging and incentivising a business’s workforce and ensuring succession of ownership, a sale to an EOT may represent a compelling alternative to more traditional PE backed or leveraged management buyouts.
If you’d like to explore how an EOT transaction could work for your business, please contact Jonathan Riley, Liz Hunter, or your usual KPMG contact.