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.