Corporate finance: structuring an EOT transaction
This blog is the next instalment in our Corporate Finance series; regarding the use of an Employee Ownership Trust (EOT) in change-of-control transactions. As we mentioned in our previous entry, the sale of a business to an EOT is a viable alternative to a third-party sale due to the ability to finance a portion of the sale and structure a path to liquidity for the remainder of the purchase price.
Here is how the transaction would typically be structured:
Assume the company is going to be sold to an EOT for an Enterprise Value (before subtracting outstanding debt) of 6.0x Trailing Twelve Month (“TTM”) EBITDA of £5 million. The Enterprise Value would then be £30 million. We will also assume the company has outstanding existing debt of £3 million. To obtain equity value we would subtract the outstanding debt from the Enterprise Value, which leaves us with £27 million of equity value.
We will also assume the company has senior (bank) debt capacity of 2.5x TTM EBITDA, or £12.5 million.
To get to the amount available for financing the EOT transaction, we would subtract the currently outstanding bank debt of £3 million, leaving £9.5 million for the transaction and fees. Assuming £500,000 in fees, that leaves £9 million for the stock purchase.
The remainder of the purchase price would be financed through a vendor note, structured similarly to third-party mezzanine financing or subordinated debt. As the initial bank loan is repaid, the vendor note would be refinanced, providing a path to liquidity for the remainder of the purchase price.
Keep in mind, that the vendor will get full Capital Gains Tax (CGT) relief on the sale, even if a portion is financed with a vendor note. In our example, if we assume the basis in the company shares is zero, the vendor would be subject to CGT on £27 million of equity value in a non-EOT sale. By selling to an EOT, even if the CGT rate would be at the Entrepreneurs’ Relief level of 10%, the seller has saved £2.7 million in CGT - that’s a pretty compelling argument for at least considering the EOT transaction.
In our next entry, we will delve more deeply into the structure of the vendor note and discuss what we mean when we say it will be structured similarly to third-party mezzanine of subordinated debt.