Role of the lawyer: Why legal representation is a must for all parties during an Employee Ownership Trust transaction | Napthens Solicitors guest blog
Guest blog by Keith Melling, Partner, Head of Corporate, Napthens Solicitors
A key feature of any well-structured Employee Ownership Trust (EOT) transition is the legal documentation. An EOT sale is a form of corporate transaction where there are at least two parties – a seller and a buyer (and sometimes a third-party funder) – and each requires its own legal representation to protect its position.
The seller needs to know the terms upon which it can receive future payment, while the buying trustee company will likewise want to understand its obligations to make payment for the company and perhaps some additional contractual protection where the seller agrees to retain the risk for the target company’s pre-sale activity.
A third-party funder requires an understanding of the deal, to settle the terms of its loan and receive adequate security from the buyer and the target company.
All of this demands the preparation, negotiation, and completion of various legal agreements.
Early stages of an EOT transaction
The lawyer’s role should commence at the earliest stage. Usually, the existing owner (or founder) of the company decides to embark upon the EOT and, once the company value is agreed with accountancy and tax advice, the overall structure should be settled in a set of heads of agreement which the legal adviser will often prepare.
The heads set out the key terms of the sale and can be an important document in applying for a tax clearance, briefing potential third-party funders and articulating the deal to any non-executive director (NED) or prospective employee council members. The heads are usually non legally binding in the context of an EOT transaction.
The lawyer acting for the buyer should test whether the board wishes to undertake any legal due diligence item into the business. Often the seller will provide little warranty protection so it’s important that the buyer is satisfied with the nature and extent of the company’s assets, liabilities, opportunities, and risk areas.
Employee Ownership Trust sale documents
The share purchase agreement (SPA) deals with the transfer of the company to the buyer. The SPA will cover the following areas, although this list is not exhaustive:
- the price payable on day one and over an agreed period. Many EOT sales involve the seller accepting payment in deferred instalments – will these payments be due on given dates; will they be calculated by reference to future available profits or cash; will interest be paid and will there be any acceleration triggers?
- provisions for the price to adjust by way of a completion accounts mechanism if the value at completion is greater or less than expected and/or by way of an earn out mechanism if the target company’s future profitability improves;
- restrictions on actions taken by the buyer which may jeopardise the seller’s tax treatment;
- the seller’s agreement not to be involved in any competing business or damage the goodwill of the target company – the very existence of a deferred price should be an incentive to prevent this;
- contractual protection in the form of warranties and indemnities around the state of affairs of the business, so that the price is reduced if an asset is found not to exist or a liability is greater than anticipated. A seller will tend to resist giving this type of protection on the basis that the trustee buyer is funding through the business, whereas a third-party funder may take a different view;
The lawyer will also need to prepare ancillary supporting paperwork such as stock transfer forms, board minutes and shareholder approvals.
EOT documents
Aside from the transaction itself, the buyer will need to be properly constituted to ensure suitable governance arrangements, which means adopting articles of association to deal with the composition of the board, its membership and the holding of meetings.
The buyer and the target company will need to establish an Employee Ownership Trust by completing a trust deed, which sets out the rules for holding and applying trust assets and co-opting employee council members to play a role in decision making. This document will be prepared by the buy-side lawyers with advice from tax specialists.
Funding agreements
If a third-party funder is involved there will be security and facility agreements to review and likely an agreement from the seller to ‘sit behind’ the funder until it has received repayment.
Shareholder and share option arrangements
This may not always apply, but if the seller retains an equity stake in the business then a shareholder agreement and set of target articles of association should be prepared to govern the relationship with the buyer trustee as co-shareholder.
This may contain minority veto protections for the seller as well as a mechanism for the buyer to acquire the balancing shareholding in the future.
A share option scheme may also be adopted to incentivise key management, which will afford them the right to directly receive minority equity holdings in the business which may be purchased by the trust in the future.
Summary
The lawyers are on hand to understand and document the terms of the transaction, to manage the process to completion when monies change hands, and to help establish the EOT with the most suitable governance structure to achieve its further success.
About Napthens Solicitors
Napthens regularly advises business owners, trustee boards and funders on the EOT transition process. With 20 corporate team members, Napthens has the necessary experience and strength in depth to advise upon the structuring and delivery of transactions.
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For more information on sources of third-party funding, see this document from ThinCats
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