Employee Ownership Trusts (EOTs) and the Role of Vendor Financing

Transcript

Garry Karch
Hello and welcome to our webinar, discussing Employee Ownership Trusts and the role of vendor financing. Thank you for joining us. Today we’re going to walk you through examples of how Employee Ownership Trust transactions can be financed, what the financing structure looks like and what it means to the vendors.
My name is Garry Karch. I am the head of EOT services at Doyle Clayton. I’ve been working on EOT transactions since shortly after their establishment, so roughly going on 10 or 11 years now. We’ve completed around 70 transactions at Doyle Clayton. When you factor in our prior lives, we’ve probably completed close to 150 EOT transactions over the last 10 years and I’m joined today by my colleague Akshay Vaghela, who will introduce himself as well.

Akshay Vaghela 
Thank you. I am the EOT Services Director here and I’ve been with Doyle Clayton since September 2024. My background is as a tax advisor, which I spent 8 to 9 years in the profession and moved into advisory and for the last 5 years of my career I’ve almost been solely dedicated to Employee Ownership Trust, administration and advice. So, with that, let’s move on.
So, as you will know if you’ve watched the webinars before, we always tend to give you an overview of the general requirements for an EOT. Many of you will know these already, but just in a nutshell, the key requirements really to qualify are.
Firstly, the business, the trading business, that means that it does not to a substantial extent undertake investment activity. So, any company that’s solely in property investment, for example, would not meet trading requirement. That said, a trading business that has a rental portfolio can still meet the trading requirement. We might just do need to do a little bit of analysis to make sure that it is a trading company beforehand. Another requirement is the controlling interest requirement. This is very simple. It’s simply that more than 50% of the share capital, a controlling interest is passing to the Trust upon sale and more than 50% means more than 50% of the shares, more than 50% of the right to vote, more than 50% of the profits available for distribution and also assets available on a winding up. So really simple requirement to meet.
The other requirement for the company is the limited participation requirement. Now in order to assess this and what this rule is for, it’s just to make sure that the company that is selling to an EOT is employee centric. This requirement, you take a snapshot of your employees at the day of sale, for example, and providing that not more than 40% of the total employee base, providing that they that those individuals do not also own shares. So, if you have, for example, an employee base of 10, you have 5 shareholders that have 10% each, you will not meet the requirement, so that’s the 40% rule. As long as any shareholder employees that own shares are less than 40% of the total, you meet the requirement. And that really becomes an issue for smaller companies, sort of single digit employee numbers where we just have to think about things a little bit more carefully because changes to the employee.
Members could affect the fraction, but generally nothing to be worried about from a qualification perspective. If you do meet these requirements, you can access EOT relief, you can sell to a Trust and that of course brings benefits such as a 50% exemption or 50% CGT relief on the gain. So, companies that are sold to Employee Ownership Trusts benefit from that and the effective rate of capital gains tax is 12% or no more than 12% if you meet those criteria. Now, there are myths in the market that EOTs are not as valuable as a third-party sale or a private equity sale (and we’ve got another webinar on that exact topic by the way, so, please do watch that) but generally, we want to debunk that myth and reiterate that they are very, very competitive, a) due to the tax relief and b) due to the flexibility and control they offer a vendor.

Now the reason for this webinar, the key point around an EOT is how is it going to be funded? How is somebody going to sell to an EOT and fund the purchase price?
So, a lot of what we do, we will talk about vendor loans, we’re going to talk about the other options which are, bank funding and there’s types, there’s different types of how that funding can be layered. So, if we can move to the next slide please.
So, as I’ve sort of touched on already, there are three key ways of financing an EOT. First is cash on the balance sheet. A lot of companies will have a lot of excess cash that they’ve built up over the years through the shareholders not withdrawing those amounts as dividends. So that’s always the free cash typically is paid out on the day of the sale. It can also be spread across payments that that go on throughout the EOTs life cycle and then there’s also senior debt. Now senior debt is really the main tranche of debt. This could be vendor debt, so that could be the entire amount of deferred consideration that’s owed to the vendor. If there’s bank funding, that could also be the senior debt. So, bank funding for some or all of the deferred consideration is classed as senior debt. Now if you have both, so in in many client scenarios we come across there will be.
A bank funding part of the proceeds. It could be half of the proceeds going to be funded by the bank and the remainder is going to be funded by the vendor. When I say funded by the vendor, I mean that they’re willing to forego receiving that on day one and leave it out as an outstanding loan note, so they’re owed cash.
And in that scenario, the bank funding tends to be the senior debt, meaning the most important, the highest-ranking debt that the company has and the amount owed to the vendor becomes what you see there as subordinated. So, a subordinated debt now generally as you move down the list as you see on the screen, the cost of having that funding increases. So senior debt’s obviously always going to carry an interest rate, a commercial interest rate and that tends to be in the region of base rate plus 3& to 4%, which is sort of commercial rate for senior debt.
Subordinated debt is riskier and carries a higher interest rate, therefore. So if we can move to the next slide.
Here as I’ve just sort of explained this is what the senior bank debt and subordinated debt, the interaction between them with subordinated debt, the pricing is fixed, the rates are higher because that debt ranks second.
So, in a scenario where you’re looking to sell to an EOT, you’ve got your senior bank debt, for example, and your vendor loan is subordinated, you can charge a higher interest rate. Now the reason we’re sort of talking about these costs, something to always bear in mind when taking external financing is that it can put a little bit of additional pressure on the company. Vendor financing, which is the topic of this webinar, is far less risky and far more flexible for the company. With end or financing, if there are hard times, if you hit headwinds with the company, profitability might reduce for 1/4 or a year, you can simply defer payments and accelerate them when the when the profitability picks back up. If you take external financing, the issue is that regardless of company performance, regardless of profitability in any given period, you must meet the bank’s payments in order to avoid any bank sort of exercising their charges over your company. So, there is a key difference. Vendor financing I’d say is the most popular. I’d say 80% of our deals tend to be vendor financed and we see less bank debt in smaller organisations because there is, sort of, limits. So, where a company sort of has EBITDA of £1 million or less, less than £1 million of EBITDA, it can be difficult to get bank funding. There are sort of smaller brokers, around that deal with smaller lending, so it is possible but it’s not very common and for bigger businesses with the £1 million plus banks are very, very willing to talk and deploy their capital in such businesses. So, vendor financing is the most popular and the most flexible. So, we can move to the next slide please.
Yes, I think I’ve covered most of these, but the key point really is that vendor financing is very, very friendly the interest terms, you can set them to a certain extent. We have, in extreme examples, had vendors that want to charge no interest to the company but we always recommend that you should charge interest and the reason for that is to give the company the Trustees flexibility should they wish to refinance part of that vendor loan. So, imagine you’re a vendor, you’ve sold your company to a Trust. You’re owed, just to make it easy, you’re £3 million over the next 6 years. You may get halfway through that period. The company might have exceeded its expectations. You might decide, look, I want to refinance the £1.5 million that I’m still owed and get that money now and by charging that interest rate on your own vendor loan from the beginning, it’s very easy for a Trustee to then take on another interest-bearing debt, whereas if you charge no interest, the Trustee then has a decision to make. Do we swap our non-interest bearing vendor loan, for an interest bearing bank loan? and that really we say look charge the interest whether you’re going to take it or not because you can defer and you can also write off. You can waive the right to receive that interest at a later date. But for the flexibility it offers, we always recommend having an interest rate in case you do want to refinance down the road.
The fact that you can do a vendor loan is really important because it makes the EOT a more mainstream option when it comes to comparing them to a third party sale or the more the more sort of known sale routes and the other advantage is charging that interest, you not only get the sales price, you also can accrue a really valuable pot of money that is taxable, but can be taken after you’ve received your purchase price. If you’ve watched our other webinars, you’ll see that we’ve been through comparison and for a £5 million deal, in that example, the vendor actually had a deferred interest entitlement of £1.2 million or there and thereabouts. So that commercial structuring can make the EOT, comparably. it can provide a higher net value than a third-party sale. And that’s why we sort of maintain that mantra of ‘it’s what you keep rather than what you get’ for the for the business on sale. So let’s go a little bit more into vendor financing. Vendor financing is usually always a senior debt. So, you wouldn’t get those 12% to 14% rates that you get for a subordinated loan. It’s lower risk so it tends to be like I said, base rate plus a spread. The maximum we would ever allow for a repayment schedule for vendor loans is 10 years and that’s has real, real basis and it’s an industry rule of thumb that if you’re looking at a business and you’re doing cash flow modelling, to understand how quickly can the company fund and repay the vendor if you’re putting every single drop of profits towards that and the repayment schedule comes out to be more than 10 years, the likelihood is the business has been overvalued, so 10 years tends to be the limit. Like I said, the rates are based on the Bank of England base rate plus the spread and you can put guarantees in place so the company can make a formal guarantee to the Trust that it will fund those contributions. So ,it’s a really secure, really flexible and friendly type of financing for the EOT and with that I will pass you back to Garry.

Garry Karch 
OK. Thank you, Akshay. So, so in the next few slides, what we’re going to do is walk you through an actual example of what an EOT transaction looks like from a structure perspective when you finance it with vendor loans. Now, the reality is you could look at this and insert a bank into the structure in lieu of the vendor. The biggest issue you’d face there is that at times the vendor loan will be a little bit higher leveraged loan than a bank might be willing to make. So, when I say higher leverage, it means it will be a greater multiple of operating cash flow or EBITDA than a bank might be willing to make. Our view is though that given the overall structure, you should look at these primarily as senior loans and they should carry a senior loan interest rate even if the debt level is marginally greater than a bank might be willing to do, the fact that you’ve got the ability to defer or accelerate the payment schedules takes a lot of risk out of the equation from a vendor perspective and, therefore, our general view is that it doesn’t warrant subordinated vendor loans at a 12% to 14% interest rate. There’s a case to be made that it could. I mean, we’re not saying that in all cases that’s necessarily going to be the right solution for a vendor. But generally speaking that’s the approach we take and I think it’s the approach that a lot of people who do what we do for a living take with their clients as well. So, to set the stage here for what we’re going to be looking at, we’ve got a transaction that’s based upon EBITDA of £750k. We’re saying that the business is going to be sold for 5 times that amount. So, it’s five times multiple transaction and we’re going to assume that there’s £500k of excess cash on the balance sheet. That excess cash becomes part of the equity value of the business. So, that can come out at completion, at the 50%.
CGT relief tax rate just like the rest of purchase price. So, you have what you call enterprise value, which you can see in our example here, is the multiple of EBITDA and then to that you would add the excess cash and if there was any interest-bearing debt, you would then subtract the interest bearing debt off of that number to come up with equity value. In this example, the equity value is £4.25 million. The way we’re going to structure that is through vendor loans. So, this will all be senior vendor debt. We have cash for the transaction. This includes the fees that would be paid. So, there’s an advisory fee and then there’s stamp duty that the buyer has to pay to HMRC and that’s 0.5% of the purchase price. So, we have total cash of £566k. We have the vendor loan of £3.75 million and then we have the purchase price and the fees down below. So, in this example, the illustrative cash at completion would be the £500k net excess cash that would come out of completion. From a structure perspective, what we’re going to look at is an interest rate of base rate plus 3, the current base rate is 4%, our spread of 3% gives us an all-in rate of 7%. Typically, that would adjust as the Bank of England base rate changes. So, it could go up, it could go down a little bit over the life of the loan but for an example, yeah, we have to make an assumption on the interest rate. We’re also then going to assume that this is going to be repaid on a stated basis over 7 years. So, it will be equal instalments over a 7-year period. With that, let’s actually take a look now at the transaction cash flows. In this particular example, what you’ll see is we have EBITDA increasing by 5% a year.
For the first three years and then we have a decrease in the growth rate to 3% over the remaining term and then to determine cash flow, what we do is we take the EBITDA, we subtract the cash taxes that would be paid and then we subtract the net cash capital expenditures, so capital spending that the company is going to make on an annual basis to come up with what we’re calling the ‘cash available for financing’. So down below that ,then we have our debt repayment schedule. So, you’ve got the senior interest. Again, we’re deferring this as we mentioned earlier. So there’s no interest paid during the life of the loan with this structure, so that will build up over time as Akshay mentioned earlier. Then we have equal instalments of principal of £536k per year over the 7-year period. You can then see what that does to the overall cash flow in the structure and what we’ve done in this particular case is we’ve assumed a beginning minimum cash cushion in year one of £39k. So, after all of the spending, after all the debt repayment, the company, based upon its projections, would still have just about £40k of cash availability in year one. That’s a number that is determined by the vendor, by company management. Some clients like that number to be a larger cushion. We’ve had some that says £75k. a £100k.
Others are more comfortable cutting it a lot more tightly because their view is they can always defer. So, if they have a down year and it looks like that they’re going to even breach that number, they will just say we’ll take a pass on the payment for this quarter, see how it looks next quarter and then you can catch up over time going forward when performance gets back to a level that generates incremental excess of cash flow. Over time then what you see, is you’ve got the excess cash flow remaining on an annual basis and then we show you a cumulative cash flow number. That’s just going to take the excess every year and you can see what that pot’s going to end up looking like and what is interesting if you look at 2030 up here, so that would be a year 5. If you look at the total debt outstanding at the year end, it’s £1,071,000 at the end of year five and you have £512k excess cash, that’s your inflection point. So, if you look at year 6, you have total debt outstanding of 536,000, yet you have excess cash now that’s built up of £717k. What that tells you, and again, all models are going to be wrong. Let’s just be real honest about that, all models are going to be wrong. It’s just a question whether they’re wrong in a good direction or a bad direction. But in theory, sometime during year six you would have enough excess cash built up that you could pay off the remainder of the vendor loan.
And be done within a six-year period. That’s one of the benefits we think of modelling transactions in this way. You can see before you actually go into a transaction what the cash flows look like based upon the guidance you provide in terms of company performance and then we can build the structure out, to see what it looks like based upon your guidance. In this particular case, you could look at this and say, what, we’ll prepay a little bit every year, which you could do, but assuming you’re close to your numbers, you’re going to be able to pay this off early, if that’s your desire.
When we look at the debt repayment analysis a little differently, you can see again we’ve kept the straight line repayment of £536k per year. You can see as you drop down below the ending balance line, the interest rate of 7%. We’ve kept that constant because we don’t have a crystal ball that says base rate is going to change at this point in time or it’s not and you can see the interest expense calculation then based upon the average balance outstanding during each year. Now we set the cash interest percentage at 0, so there’s 0 cash interest being paid deferring as Akshay mentioned earlier, deferring 100%. So this is the real key and part of the magic of the vendor financing structure when it comes to evaluation and how much you’re going to get at the end of the day as the seller. So the deferred interest line you can see in year one is £244k, goes down to £206k because you paid off principal, so there’s less debt outstanding. Therefore, the interest is going to be less than that year and you can see that pattern following through to the end of year 7. What this really leads to then is by the time you have paid off the purchase price, you will have built up over £900k of deferred interest. That’s yours, as a vendor.  That can be paid out in a lump sum. If the company’s cash flows permit it, it can be paid out over time. It really is going to be done at the vendor’s preference based upon cash available at the trading company and that’s built into the documentation that is taxable as income so just be real clear about that. So, if you’re in the 45% income tax bracket, you’re going to be giving HMRC a reasonable amount of that, but you’re still going to end up with a very significant amount of additional cash and this goes to the point that Akshay mentioned earlier, when you look at how this compares to a trade sale or private equity and we would encourage you to take a look at our ‘Introduction to EOT Transactions’ webinar from February of 2026 because we show you exactly how these examples work and that £1.2 million that Akshay mentioned of interest came from the example in that particular model in the webinar. It really is, the I wouldn’t even say the great equalizer, it can be what makes the difference in making this a better transaction from a financial perspective than a trade sale or a private equity transaction. So, you’re not only getting the £4.25 million of purchase price here, you’re getting another £919k gross of interest and let’s just say that equates to £600k net, maybe £550k net. So, you’re going to end up with somewhere between, £4.7 million and £4.8 million of value on a net basis in the transaction. Again, you still have 50% CGT on half the proceeds but it still is a very attractive alternative compared to the other transactions where you’re going to be paying CGT, potentially part of it at the business asset disposal relief rate, but the other part at 24%, which is, a significant increase over the effective 12% with an EOT.
So, going to the credit metrics and this is what a bank would look at, as they underwrite a transaction and we take the same approach. I think, Akshay and I are both corporate finance professionals. So yes, as we look at these, we say, “OK, how should this look from an overall structure perspective to make it reasonable from a third-party lender perspective?” because we sort of translate that to what vendor loans should look like. The difference and I mentioned this earlier is if you look at the opening leverage number and when we say leverage that’s going to be debt to cash flow, debt to EBITDA. If you look at 2026 here, you’ll see that the first year’s number is 4.02x you would not find a bank that would lend at that multiple, maybe a credit fund an independent credit provider, but as I mentioned before, because you’ve got the flexibility as the vendor to defer or accelerate in a good year. That leverage number isn’t quite as relevant in this particular context as it would be if you had a bank coming in to do the financing. So, it would be high for a bank, still within the realm of the reasonable from a vendor loan perspective, that drops significantly over time then from the 4.02x and by the time you get, a little past the end of year three, you’re down below 2x again, which is basically, I won’t say, an easy transaction for any lender, but it’s not a difficult deal for a third party lender to do a 2-2 1/2 times multiple transaction. The more important part here is going to be the debt service coverage ratio, call it fixed charge coverage. There are a number of different names that that are applied to this but when you look at this, so in year one, we’re showing that you can cover your debt service obligations by almost 1.1x . So, the cash available for debt service, which we calculated on the previous slide says that we’ve got 1.07x cash flow coverage. Now, this will vary based upon what you set is your annual cash cushion. Based upon what you want to keep in, you can generate more cash available if you want to. This number will look fine. The reality is when you look at it from a venture loan perspective, if you’re above 1-to-1, you’re fine because that means you can cover the payments as they come due. If it looks like you’ve hit some headwinds, you just defer for a quarter, two quarters and get back on track when cash flow picks back up. So, looking at 1 and above, you can see these numbers look very strong once you get into the second year, we go all the way up to almost 1 1/2 times by the time we’re done paying this off in year 7. So strong cash flow, would say this is satisfactorily structured from a covenant perspective. Typically, vendor loans won’t contain covenants, but this will guide the repayment schedule calculations that are put in place up front, in the transaction.
Hopefully that’s given you a sense of how these can be structured what you consider in terms of structure. The real key is going to be the excess cash flow on an annual basis because that will then drive the repayment period. We’ve used seven years if somebody said I’m willing to do, £10k of excess cash. We might shorten this to 6, but it’s easier from our perspective, we think, to stretch it out a little bit and then accelerate if you need to or if you can, rather than having a really short repayment schedule where then you’re always deferring something.
I think the optics of that look far better with a reasonable beginning point and then acceleration rather than an artificially low repayment schedule and then a lot of deferrals over time. So that’s kind of the philosophy behind the structuring. Akshay, let me turn it back over to you.

Akshay Vaghela  
Thank you, Garry. lots of advantages to vendor financing, lots of flexibility on offer. and just to kind of round off this webinar, we’ll go through the value summary for an EOT. Obviously, the CGT relief’s a major one. It allows vendors to keep more in their pockets and you get that 50% CGT relief when you sell to an EOT. So that basically means an effective rate of 12%, which is the lowest on the market for an exit at current at present, even lower than business asset disposal relief, which is currently 14% raising to 18% as of April. Also coupled with that, the opportunity to pool cash in the company that’s being sold to Unity and extract that at the 12% rate rather than dividend rates. We have many clients that have excess cash pools in their company, mainly because they haven’t taken that cash in the past to avoid dividend taxes. When you are preparing for the EOT sale, that cash can come out at really efficient rates, at CGT rates and specifically at 12%, which is, which is brilliant. Also, as we’ve been through the commercial structuring and Garry and I are of the same of the same opinion on this, that commercial structuring with that vendor finance, with that interest is really, really valuable and can set apart the EOT compared to any other sort of final exit route. So having that £919k of accrued interest that Garry mentioned earlier is super valuable and provides you with another pot just because you’re willing to wait as a vendor, you’re willing to wait for the cash and you got rewarded by, for taking that risk with the interest. So again, really, really valuable and we tend to call that building a second pot, second retirement pot. It is taxable but it’s we’ve had clients that have built up a part of, if we use an example of £400k through their sale and they choose to take that over a period of five years as an income stream because often after you’ve sort of, as a vendor, if you’ve ceased your employment.
You’ve been paid your tax efficient principle. You might be in a position where you’re not earning as much as you were before. From an income tax perspective, you can take the interest in a really efficient way and plan forward and the general benefits as well, swift sale control over the sale process. You can create your own buyer, you can set the terms, you can get a really good valuation, competitive one. You can charge interest on what you’re owed and you get to control the process. For straightforward sales, you can do an EOT sale in 12 weeks. If you’re taking external financing, it could be a bit longer. But the point is, throughout that whole process, you’re in control. There’s no third party sat there opposite you trying to drive you down on value, looking really forensically at your company and it tends to be a lot friendlier and a stress, I would say stress free. It’s never stress free. It’s less stressful, far less stressful and lots of our clients will echo that, and then the really, really important point as well, which can often get forgotten in sort of, thinking about the sale and the.
In the 1st place, it’s the benefits to staff, it’s the benefits to the organization that each beneficiary, so each employee of the company that’s owned by an EOT can receive tax free bonuses of up to £3.6k. For those bonuses, they must be calculated in a specific way based on renumeration, length of service, hours worked or equal shares, equal bonuses to each employee is also fine and there’s also a huge opportunity to incentivise key individuals. So as we as you might have heard us say before when you sell to an EOT, you might need time to build the management team that’s going to replace you if you’re looking to move on and as part of that, being able to offer EMI options can be really, really valuable. Especially because after an EOT sale, you’ve got a company that was worth X millions, but it also owes the same amount to a vendor. So when you’re looking at valuing A minority share option, you can get a really favourable valuation for a key employee that can be locked in at that date and then you can put performance conditions for that employee to meet, where they can pay that price and acquire those shares at a later date when the shares are undoubtedly worth more than the price that was locked in. Once the EOT is paid off, all the financing has been paid, be it to a vendor or a bank, all the interest has been paid. You then have a company that is pooling cash, pooling profits, does not need to, doesn’t have a shareholder stripping those profits out as a dividend.
It doesn’t need to send money through the Trust to pay off vendors, and ultimately that can lead to fantastic, remuneration packages for staff, bigger bonuses and also, the opportunity for the company to invest better in the benefits it offers. So, you could have better insurances, better private medical covers, a whole host of different options that having that cash gives the opportunity to the company to do. An EOT sale can really boost that morale and the incentivization of the staff member and the motivation of it and their whole experience of being with a company that that is owned by an EOT and often that’s the reward that they deserve having helped an owner or a founder build the company to the point of sale. So really big benefits for staff and that’s why we always say, look, EOTs are not for suitable for every single company in the UK, but for a large number they will provide amazing solutions and an amazing flexibility and with that, legacy preservation which a lot of our founders find really important. We speak to vendors, people selling to the EOTs, they really value the fact that they can stay involved in their company to a certain extent, that they can watch what they’ve built continue and preserve the culture that they’ve built that’s made them so successful and that’s really important. So, when considering a sale, we say that all vendors should at least at the very least consider an EOT and something that we do to help with that is we offer a complimentary feasibility analysis. So, we will work and we’ll have conversations and we’ll work with vendors. We’ll request some financial information about past performance and growth projections and we can put together an analysis that gives an indicative value and also shows, the repayment period, the amount of interest and really essentially gets an owner to the point of having all the information they need to decide whether the EOT route is right for them. We do that as a complementary piece, which is rare, but because our job in our view is to make sure that anyone we speak to has the information they need before they decide to commit to, what can be significant fees to do the sale. We don’t think you should be charged for gathering information and understanding what it could look like for you. So yeah, look, that’s a summary of the of EOT sale, the financing and the benefits. I’ll pass it back to Garry.

Garry Karch  
OK. Thank you, Akshay. In closing, on, we’d like to thank you for taking the time to watch our webinar today. We greatly appreciate it. If you do have questions, our e-mail addresses, we’re on page 2. Feel free to reach out to either one of us. We’re happy to schedule individual follow-up calls. We’re happy to respond by e-mail to any questions you may have and again, just to reiterate, if you’re interested in seeing what a potential transaction for your business could look like, we are very happy to do a feasibility analysis for you. No charge, no obligation, but It’s just we’ve always found it very difficult to conceptualize that somebody should have to pay to see what the information they need to make a decision. So that’s the reason we’ve taken that approach.. We will do that and if you move forward, great, if you move forward with us, even better but we’ve had situations where we’ve done these and someone said, I just don’t think this is the right option for me and that’s fine. It is not the right option for everyone, as Akshay has mentioned several times, but it does work for a lot of people in a lot of companies so with that, we’ll say again, thank you and please feel free to reach out with any questions.