Principal Contractor

Employee Ownership Trusts in the Construction Sector

A Case Study

In June 2020, RVE Corporate Finance advised on the sale of a principal contracting business based in the South East of England to an Employee Ownership Trust.

In the summer of 2019 the Founder of the business was asking himself ‘What next?’.

He had founded the business in 2001, worked hard, taken some risks and built a successful business.  He wanted to release some of the value he had created in the business, but was not yet ready for a complete retirement.

The Founder considered his personal aspirations, his business goals and time horizon – all of which pointed towards a possible sale of the Company in the next three to five years.  He spoke to a local firm of accountants to try to find out the potential value of the business and how best to achieve the desired outcome.

Initial indications were not at all encouraging.  All of the normal routes to achieving his goals presented some obvious and significant challenges.  These included the potentially negative effects of selling to a third party, failure to realise full value for what the business is worth and sale transaction execution risks.

A sale to a financial/private equity buyer was ruled out on the basis that an SME construction business – even one with a stable, profitable trading history and a good forward order book – was not of interest to that community.

Similar issues applied when he considered the option of a trade sale.  Although he could identify potential purchasers, it was obvious that valuation would be contentious and there would be a risk of ‘price chipping’ – both during the pre-sale due diligence and subsequently via warranty claims.  Perhaps more significantly, however, there was the likelihood of losing the people culture that the business had been built on and the dismantling of the leadership team that had been painstakingly assembled over the preceding few years.  He therefore concluded that this would not be an acceptable way forward.

This led the Founder to seriously consider the option of a management buyout, i.e. selling the business to some or all of the other directors.  There were some obvious attractions to this route.  It was likely to be easier to agree a value with people who knew the business intimately; the transaction execution risks would be greatly reduced, and the team culture would be preserved.  However, there was one major obstacle: private equity firms would not fund such a transaction and the management team couldn’t afford to pay for the business outright – their source of funding could come only from the company’s future profits.  This presented an unattractive risk to the company’s founder, who would have to hand over control in exchange for an IOU.  He concluded this wasn’t an acceptable way forward – particularly as he wasn’t thinking of scaling back his commitment to work for a few more years and there was a risk that the prospective MBO team would not be able to succeed without him.

Based on this analysis, the accountant’s rather discouraging advice was that the Founder’s best course of action would be to retain ownership for the next few years and accept that he would have to pay high rates of tax on any value he wanted to take out of the company – either as remuneration (salary and bonuses) or dividends.

In December 2019 the Founder’s legal adviser arranged a meeting between the Founder and RVE.  Gerry Young of RVE confirmed the analysis the Founder had already undertaken of the options outlined above.  He then asked if he had considered selling the company to an Employee Ownership Trust (EOT) – a John Lewis style of business ownership structure.  As the Founder went through the implications it became apparent that this option could tick many of the boxes on his exit options checklist:

• A fair value on exit, which fully reflects the company’s worth, based on an independent valuation set at a market multiple of the Company’s sustainable profits.

• A mechanism to pay a substantial part of the sale price on day one, with the balance payable out of the company’s future profits over a five-year period.

• Continuing involvement for the founder in running the business, with provisions to protect him until the sale price has been paid in full.

• Preservation of the company’s culture, which would be built on by all of the employees having an ownership stake in the business.

• Finally, and subject to meeting the relevant conditions, the whole sale price would be free of any income or capital gains tax

The Founder at first did ask …. ‘surely this seems too good to be true…….?’ So he investigated.  He talked to several entrepreneurs who had already sold their businesses to an EOT and were all really positive about both the process and the outcomes.  He looked into the technical aspects and researched the topic with the Employee Ownership Association.  Lastly, he took advice from a third party tax adviser, who confirmed that a specific tax relief is available to entrepreneurs selling their stake in a business to an EOT, which means the whole sale proceeds would, indeed, be tax free.

With all of the boxes ticked and checked, he concluded that this was a really good plan and the right time to go ahead with it.

The deal implementation process ran smoothly.  The business valuation reflected a fair price at which the Founder and the other shareholders were happy to sell.  A tax clearance was obtained from HMRC within a month and the sale process was completed a few weeks later.

So, what has changed in the immediate aftermath of the EOT transaction ?  In short, nothing but everything!    The executive leadership team is still in place.  The Founder is continuing to perform the same role as CEO, albeit with a plan to scale back his work commitments in the next five years.  He has been paid a significant amount of the sale proceeds – the reward for many years of hard work – free of tax, and will benefit from payments for the balance of the sale proceeds over the next 5 years.  Importantly though, ownership of the company has changed hands.  It now rests with the employees, who are gradually coming to understand what this means for them.  The company hopes to see a greater level of engagement, which should only increase once employees are able to share in the profits they have helped to create.