People and preparation just as important to consider as finance when funding an EOT | ThinCats guest blog
ThinCats’ slogan is ‘helping the mid-size thrive’, with its sights set on filling the finance gap for SMEs that are evidenced as struggling to access the finance they need. In the lead-up to ThinCats publishing its Guide to EOTs, Head of Credit Greg Beamish, pictured, shared his insights in this guest blog:
For the founder of a company, handing over the reins can be one of the most difficult things to do. They have spent years building up a business, may know every individual employee, and know what they want for the future of the company.
Once they have decided to sell, business owners have a range of succession planning options available to them. Management buy-outs are challenging without a proven leadership team, while third-party sales may not appeal to a vendor who wants to safeguard the core values and identity of their firm, while also rewarding and protecting the staff who have been instrumental in its success.
Employee ownership is a great option to consider if a founder wants to secure the legacy of the culture they have built in the business. The Employee Ownership Trust (EOT) enables a company to become owned by its employees via a trust – in 2021, EOTs accounted for one in every 20 private company sales in the UK.
The guide we are producing at ThinCats provides more background on EOTs on how they work, the qualifying conditions, key considerations, their cultural and tax benefits, why businesses are increasingly choosing this route, and the funding options available.
Awareness of the EOT as a succession solution is growing. However, a lot of people are still not sure how to approach it, so we want to let owners know this is a potential route to exit and grow knowledge about EOTs and what they can offer.
We can help fund such a transaction. There’s something pretty pleasing when you’ve managed to allow an owner to transition their business to the people that have put in the blood, sweat and tears to grow the business. Ultimately, an EOT is a great way to facilitate ownership change.
ThinCats has worked with numerous companies over the eight years since the EOT structure was introduced, helping them achieve the best outcome for their long-term success.
A lot of EOT transactions seem to be delivered by taking cash off the balance sheet so there’s relatively little upfront payment. SMEs, in particular, can struggle to get funding from banks as they are more used to lending relating to assets rather than lending against cashflows. Employees that become part of the trust generally do not have the capital to put in, so the loan means that usually the owner will be paid out over a multi-year period.
We can provide funding, generally a 3-5 year loan, which facilitates a day-one payment to the owner and allows them to take some actual cash off the table. Through looking at the quality of the business and the underlying earnings, we’re able to take a view on the leveragability of that business and how much debt it is prudent to put against it given its cashflows.
We recently helped a well-established independent financial adviser firm achieve a sale to an EOT by providing £5.125m of funding for the transaction, which was approximately just over two times profit.
We really liked the fact that the directors, after receiving a day-one payment, didn’t just say ‘we’re off to the beach, see you later’, they stayed involved and gradually transitioned over. Also, the newer directors had been running the business with them for a number of years before the transaction.
In terms of cashflow, this business has very sticky revenues that hadn’t really changed much year on year, meaning it could weather reasonable sensitivity to its inputs and still service the debt we’d put in place, and continue to pay out the deferred consideration with quite some cushion to spare.
So, it really brought together good structuring, a quality business with good cashflows and a thoughtful vendor and new management team who had engineered this EOT a few years back, meaning we can see a coherent stewardship of the business going forward.
I can talk about alignment of structuring and cashflows, but considering the people and preparation part I think will help people the most.
The key to all types of investing or lending is all businesses are ultimately about the people – the management team and those that work with them – and it’s key to understand how the cultures intermesh and how it’s going to change post-transition.
But the word I keep coming back to is preparation. The owner can’t just wake up one morning and go ‘right, I’m going to give this to my employees’, it’s got to be seeded over at least two years I would say, which will really allow a much better transition.
Quite often people are very focussed on the day-to-day efforts of their business, which is to be expected, but if you’re doing an EO transaction, you really need to put in place the structures, that preparation and plan to get you there, as everyone needs to be on the same page on how the business is going to work moving forward.
There’s the obvious things such as the financial planning and your forecasts, the nuts and bolts of finance, but there’s also the softer things such as how do I engage with my employees, at what level do I bring in first and second-tier management, and when do I speak to the workforce as nobody likes surprises if you just hit them with the news, you need to foster the message.