How New Legislation on EOT Valuation is Reshaping Business Exits
In this episode of the Exit Insights podcast, host Daryl Bates-Brownsword welcomes expert Kevin Harrington to discuss recent UK legislative changes impacting Employee Ownership Trusts (EOTs). With new requirements for independent third-party valuations, the Labour government aims to ensure that employees entering into ownership pay a fair price, bringing confidence and security to the process.
Kevin shares why this is crucial for anyone considering an EOT structure: “Reverse due diligence helps employees and trustees understand what they’re getting and the fair market value. After all, everyone deserves to leave the party with a balloon.” This approach goes beyond compliance and allows businesses to transition smoothly to employee ownership, equipped with insights into profitability, risks, and growth opportunities.
The episode highlights Succession Plus’s Business Insights Report, an invaluable tool that prepares a business by providing an actionable growth and risk management roadmap. Daryl and Kevin explain how an early start with a report allows business owners to test out an “earn-out” phase before exiting, which can help them get the most value and ensure the new leaders are well-prepared for ownership.
For any business owner exploring an EOT transition, this episode is a must-listen, offering practical steps to secure a fair, profitable exit.
Watch the episode here:.
Welcome to the podcast that’s dedicated to helping business owners prepare for exit so you can maximise the valuation and then exit on your terms. This is the Exit Insights podcast presented by Succession Plus. I’m Darryl Bates-Brownsword and with me is Kevin Harrington. And today we’re talking about something new and topical and rather timely really. Kevin, how are you today?
Very well, Daryl, very well indeed. Yes, it’s unusual, isn’t it, that we get an opportunity to do a podcast that is really up-to-date with things around legislation. Quite often in our business and our industry, legislation moves a little bit slowly, but we’ve got a topic today that, I mean, your suggestion, and I’m very apt as well, that is important and bang on time to deliver.
So what are we talking about? Where are we? This podcast is being recorded early November 2024. We’ve got a new Labour government in the UK and they have just released their first budget. And one of the changes to that budget is some changes to the EOT, the Employee Ownership Trusts. And a lot of the changes, they’re not big changes. If you have a look at the changes, I think they’re all pretty good. They refer to really just best practice in implementing EOTs and transitioning to employee ownership. And they are really in line with the spirit with the intent of what was intended for the implementing of employee ownership trusts in the first place. And specifically, what we’re going to drill down on today is the new requirement for trustees to get fair market valuation, fair assurance for the beneficiaries or the employees of the EOT that they’re not overpaying for the business. So there’s a new obligation on the trustees to get an independent third party valuation and not just the accountant or the business owners going, want to sell the business for this much to the trust. Kevin, what do you think?
A very important topic and the specific thing that the legislation is saying in the budget is that there should be a fair market value assurance and that is well beyond just going give us a number what’s it worth and someone saying well I think it’s probably worth four and a half million or whatever this is about giving someone a proper assurance through an educated look at the numbers and the business beyond just profit and a multiplier to give a proper assurance. And isn’t this right for anyone that’s looking to buy any asset and especially in buying a business is you want to know what you’re buying, you want to know what it’s worth today and you want to have an indication of what it could be worth. If you have those things, you can then make a good decision. And it’s, mean, the buzz phrase for it is reverse due diligence, isn’t it? That’s what it is and that’s what people should be doing.
It’s good practice. You’re bang on there. I think it’s just good practice. if you think, as you mentioned, whenever we buy anything, we want to make sure that what we think we’re buying is what we’re actually buying. And it’s clear. And we generally have some knowledge about what it is we’re buying. And it’s interesting because when we move to an employee ownership situation in a business, with the EOTs, we’ve seen a number of businesses go through the process where yeah, they’ve taken their business to market. They weren’t able to sell it. And then they said, well, you they got some advice that said, well, you know, convert to an employee ownership trust, sell it to your employees. How does that work? Well, it kind of doesn’t matter. You just make it employee ownership and you can get all the proceeds of that capital gains tax free as long as you sell more than 50 percent of it to the employees. Now, this has been happening and and what the downside of that means that there’s been no planning whatsoever.
There’s a whole lot of fear in the employees. They’ve got no idea what’s going on. They’ve got they got often I’ve heard of stories where they weren’t even involved. There was no prior conversation. They just rocked up to work the next day and were informed that it’s now employee ownership. Yeah. What better way to create some fear? But that happens in organisations where there was often already a big gap between with skill and knowledge between the owners and the next layer anyway.
And the downside is that the owner has just given themselves the longest ever earn out period that they were ever going to get. Whereas, you know, most earn outs are two to three years. Now they’ve got five to seven years where they have to keep being in the organisation. The business that they’ve started and owned, they want out now, but they’re now locked in for the next five to seven years because they didn’t do any planning to make sure they get all their money. And I think what we’re going to see is with this owners or this responsibility to get a fair market valuation is that the trustees are gonna wanna take more interest and they’re gonna start to go, well, hang on a sec. If we’re buying this business, what is it we’re getting? We’ve worked there and we’ve only ever seen it from an employee perspective, but we’re taking on some ownership responsibility, especially if we’re gonna become the trustees, what are we getting? What does it mean to us? Do we have a choice?
Yeah, this is exactly the point, Darryl, and well put. And I see this in a layered level of benefits as well. For many people, well, some people unfortunately won’t even be aware of this as a new requirement. So they’re putting themselves at risk when they get involved in setting up a trust and buying the business into the trust and so on. But let’s assume people do know that they should get a fair market valuation. It’s one of those things that you could take the attitude of saying, well, it’s just tick the box. I went to someone that’s an independent third party, I gave them a few bits of information and they gave me a fair market valuation. Arguably, yes, they could say they’ve completed their task. It could be challenged, of course, if it’s a really simple valuation like that, which does put individuals at risk for not having being responsible in their actions and it does put the trust at risk because they’re not knowing absolutely what they’re buying. So the next level is saying, well, okay, you can tick the box, you’ve complied. Compliance is really important, isn’t it? Of course it is. But when you get beyond compliance, what are you getting from a proper third party valuation and report on your business? And the thing that we’ve talked about only recently is the concept of who is going to be running this new business under an employee ownership trust, and who are the trustees. Now, most of those people are quite likely to not be very experienced business owners and business leaders. And if you get, mean, our Business Insights report, which we would see as a worthy solution to this, gives people a report where it educates them about the business. It talks about what the business is worth today from a buyer’s perspective. So that’s a fair market valuation, what a buyer might pay for it, not what you think it’s worth. It gives you that, and it then tells you how you can potentially grow the business, what the risks are. It tells you how you could evolve the business. And what a great set of facts and bits of information to have right at the get-go for an employee ownership trust. It can form the backbone of the new strategy for the business. You to take it onto its new future with its new ownership.
Totally. Yeah, look, you’ve jumped straight in and we’ve identified the problem that, hey, look, we need to know what we’re buying as a business and as trustees. We need to have some due diligence around clarity of what the state of affairs is. And you’ve identified that, hey, look, Succession Plus just so happens to have a tool that addresses this. What we think, in our view, better than most, it’s not just evaluation. Like, yeah, we a business could get just a fair valuation at this point and they’d be very compliant. But it’s partly helpful for them, isn’t it? We’ve got, as you stated, we’ve got a bunch of people who are new to business ownership. They’re perhaps a little concerned, they’re a bit bit cautious and they’re going, what is it we’ve just taken on? So what I love about the Business Insights report is it sort of jumps on the same side of the desk as the owners and says, look, here’s how an outside person is going to value your business. Here’s what they’re going to do through the due diligence process. Here’s all the risks they’re going to uncover. Here’s how they would value your business. Here’s the reasons why they haven’t valued it higher. And it takes them through a complete educational step-by-step process of presenting all of the information, all of the risk, complete analysis of your business. And as you say, based on today. And it goes, here’s how the valuation will be calculated term today.
Now I can hear people out there going, yeah, yeah, yeah, Darryl, but a business is only worth what people are going to pay for it. And I acknowledge that. But this is just a starting point, right? This is a fair market valuation. And so we go, there’s what a business is worth today. But that’s not the end point, is it? Like, what do people want? They’re going to go, OK, so how do I get that higher? It’s the first question anybody’s going to ask if they buy something new. They’re going to go, how do I get a return on my investment? Now, the Business Insights report provide you with the information because it includes some benchmarking that says, now from a profitability perspective, here’s how you rank to all of your peers and best in class. And here’s the two steps that you could improve by improving your profitability, which now that you’re employee owned, we know there is research to suggest that employee owned businesses do improve their profitability now because everyone’s aligned as much as they can be to the same outcomes. So profitability goes up because everyone’s taken a much greater interest. And here’s the impact on the valuation. If you achieve those goals, here’s the impact on your valuation. They’re just choices. And the insights report then goes another step further and says, now you’ve got a whole lot of intangible assets and a whole lot of risks that influence the multiplier of the business valuation formula to get your enterprise value.
What do you have to do? What are the opportunities for you to increase and improve and build on your intangible assets and increase the multiplier and improve the valuation again? So it sets out a plan to go, OK, new owners, here you go. Here’s what you can do. It’s an assessment of the asset you’re acquiring. And here’s an assessment how you can improve the asset value, thus the opportunity for you. And in most situations, it’ll go, here’s the opportunity for you. And I guess in some it might show up as you want to run. This is not a good opportunity.
Yes, and of course that is the underlying point with the Labour Party’s budget on about EOTs is making sure that the employees and the trusts that the employees have beneficial ownership of don’t get turned over, they get a fair deal. The idea is, and we support this wholeheartedly, is that for many businesses, the business owners exiting through an employee ownership trust is a great way of going. It can be fantastic for the business and the individuals and the economy, but like most things in business, if you do it the wrong way, it’s gonna be a messy old affair. And that’s not what we want employees to end up with out of this.
We want to make sure that, well, there’s two things here, isn’t it? We want business owners to get the most from their life’s work. Founders who have built their business up over many years have increased and built the value of the business. We want to help those guys out to make sure they do get an exit. We want to change that stat that 80 % of businesses, business owners that take their business to market don’t get a deal. That’s got to change that. It’s avoidable. That can be fixed. Now, having said that we also think that employee ownership is a great opportunity as well. Selling your business to your employees has got to be a win-win. We want business owners to get the most from their life’s work and we want employees to benefit from this. So we’ve got a win-win here. So what I think is going to be really interesting is that the accountants and lawyers and business owners are a bunch of creative people. What are we interesting to see is how they structure deals moving forward to incentivise and motivate everyone equally, because if the business owners sell their business to the employees today at fair market value for today, that’s great. Fantastic. Win-win. But then if the business owners need to be involved in the business for the next three or five or seven years in some sort of earn out or earn in or whatever we want to call it, how do they benefit from the increase in valuation over the next three to five years? That the business will go through because now they’ve got everyone aligned. Is there any additional incentive for them? And I’m sure we’ll figure out some ways to keep them aligned as the employees now benefit from the increase in valuation and the bonuses they get through the EOT structure. I’m looking forward to that one.
Yeah, it’s all good points. of course, businesses where shares are publicly traded, it is remarkably easy to value a business, remarkably easy. But our experience and our practical experience, as a business, we’ve been doing this since 2009. We’ve seen a few of these things happening. The reality is that a solicitor’s or an accountant’s immediate view of what a business is worth, of course it has a value, but it’s not addressing what those opportunities are as well as what the risks are in this full way that you’re describing. And a friend of mine who just exited part of his business earlier this year, one of his favorite phrases is, everyone needs to leave the party with a balloon.
And the person is leaving the party without the balloon and without part of the cake. They’re very upset people and they’ve got, you it’s not what any of us want. We want everyone to leave the park with a balloon. And they’re actually leaving the party at different times. The business owners are going partly pretty quickly and the employee ownership trust will keep that business going for quite a while. It might end up selling, being a trade sale and people need their balloons.
They might care about running it for decades, who knows? But if it’s set up and structured rightly with people having the right expectations, having the information they need to create the right strategy and to mitigate risk and to maximise opportunities, it can start off really well with everyone feeling happy and comfortable.
Yeah, and I like that analogy because the thought that came to my mind is like the Christmas family gathering. You send the grandparents off early at home to bed with a balloon and a bit of cake and the younger generation stay around and party bit longer and have a good time. everyone’s a winner still. So we talked about the Business Insights Report. We talked about how it provides value and it’s a really helpful document and analysis for new owners of the business, because instead of just getting evaluation, they get some analysis and they get a perception of what all the risks are and how they can increase the value of the business.
What else can you see around the Business Insights report? what else would you see, Kevin, that would be really helpful for, let’s call it new owners of the business moving forward? We talk about, cultural change is one of the things that comes to mind for me of going, employee ownership’s a great business model to have, but it needs to be the right culture to make it work.
Yes, and I mean, very often people when they transition into an employee ownership trust for the business, the culture kind of carries on because the people make the culture. But the point that you have to recognise is that very often business founder or founders were a big part of that and all of a sudden they’re going to play either no part in the business or a reduced amount of time in the business. And so how do we backfill that knowledge? How do we backfill their contribution to the culture? How do we understand and work on the values, et cetera? And a Business Insights report does pick up on this about to what extent a business has been dependent on the founders or is dependent on the founders. And it almost gives a shopping list of things that need to be looked at or not looked at in so much detail to successfully move the business forward. And I think that the specific thing that if people studied the Business Insights report in depth gives them is a probably a 12 month focus on if we accept all of this, if we’re happy with the pricing or we’re happy with the terms of the Ownership Trust, Employee Ownership Trust, here’s what we have to do to look after our customers, to look after each other, our business colleagues and the rest of the employees in the business and get things going forward safely. What you cannot have is a business going, right, we’ve done the deal, the employee ownership trust is running the business now, now what are we going to do? That’s very dangerous, especially in competitive markets whereas the Business Insights report gives that list of things that really must be focused on where the value sits and where that value needs to be protected.
Yeah, you’ve nailed it, Kevin. And which is kind of why we do things the way we do, don’t we? We we work when we work with a business, we’ll say to the business owners, why don’t you do the business insights report 12 months, two years before any intended exit? And then you can act as if you’ve already sold the business. Imagine you’ve sold the business today and it is under new owners. So what would you have to do? What would your earn out period look like? What would you be doing? And what would the new owners be asking for from you?
So why don’t you complete that earn out period, that transition period while you still own the business. Work for it for the next two years, working through that earn out period, which by the way, you’re increasing the valuation and we’ll repeat the valuation process of the BIR and produce a new BIR for you every 12 months. And that way you can work through and you can see the incremental steps that have been made from the increase in valuation from all that work you’ve done.
You can increase your valuation over two years. You get the business exit ready. You reduce and eliminate any requirement for you to be involved in the business after that transition date. So you can sell the business to the employees and really lessen your involvement after that period because you’ve prepared and planned and you’ve completed your earn out period before the business has changed hands. And there’s the best way that you can get the benefit from the increased valuation before, you know, at that transition time of the EOT. There’ll be some other and there are some other ways that you’ll be able to do it. You don’t have to sell the whole business. You might be able to work and get some bonuses, but there’s some options there for you. So we would recommend you, you work the earn out or act as if you’re working the earn out while you still own the business and you’re actually in a position to make control and and make the changes that you need to make.
Yeah. Yeah. And where we started from today on this podcast was talking about the fact that there it’s a requirement, a fair market valuation is a requirement. If people don’t do that, when they’re creating the trust, they’re at fault and they’re liable. So if you have to do one, why not do one that’s on steroids, that gives you the information is way beyond the basic requirements.
And frankly, not hugely dissimilar in terms of the amount of effort you need to put into it or the cost of it that will deliver benefits way down the road that will be good for everyone and everyone leaves the party with a balloon. Big red.
Yeah, brilliant. So what do we have to do next? If this conversation has caught your attention and you thought, hang on, there’s an idea. I now need to get evaluation anyway. I may as well get a good one. What do we want to do next? Well, I guess and if you’re looking at the YouTube version, you’ll see I’m holding up a book now called It All Begins with Insights. That’s a let me just have a look. It’s. It’s about 80 odd pages, if you like, of a standard book. So five mil thick, if you like. So there’s an Ebook that tells you and it’s step by step case study of everything that’s involved in a Business Insights report, how it’s prepared, how we prepare it, what it looks like, all the information. If this has captured your attention and you’re interested to learn a bit more, we’ll include a link to download that e-book in the show notes. You’re welcome to have a look at it and and start to get yourself ready.
Yes, and not everyone wants to read an 80 page book. We’re very good at drinking coffee or having chats on the phone. So if people want to get in touch, we’re more than happy to spend some time talking to people about in more detail about how we would operate for a business in whatever sector you’re in. People are very between manufacturing to service businesses to B2B businesses, etc. We can talk about how that would work and what it looks like and give one or two examples of what we’ve done with some other businesses to give some confidence on this being the right route for you.
Well, it all begins with insights, your valuation, your transition to EOT will all begin with insights. Kevin, thank you for sharing your insights with us today. That’s all we got for you this week.
Thank you.
About Kevin Harrington
Kevin Harrington- Succession Plus UK Partner
Having worked in technology, telecoms, consumer electronics, payments, media and publishing, Kevin has enjoyed an interesting career history that embraces product and services businesses at all stages of their journey.
Before joining Succession Plus he was CMO with The Panoply plc, a digitally native technology services company, founded in 2016, with the aim of identifying and acquiring best-of-breed specialist information technology and innovation consulting businesses. He joined The Panoply from Tungsten Network where he was Chief Commercial Officer.
Previous roles have included working with SMEs and large international businesses. Some highlights are Managing Director at the Emerging Payments Awards and the Prepaid Awards; Managing Director of Gx; Director of Sodexo Motivation Solutions; Global Marketing Director at BBC Worldwide; Product Group Marketing Manager with Sony UK.
His career started out in a completely different direction. His first two full-time roles were as a junior in an architect’s office and a civil engineering technician. Some of his drawings and designs were constructed and are still standing.
If you would like to learn more about how to start preparing your business, then you can get more information here: https://page.succession.plus/it-all-begins-with-insights-exit-insights
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