EOT Company ("PAMELA")
Pamela Limited is an owner managed business which was founded by its CEO Ms Pamela Smith. Pamela Limited has grown steadily since it was started 20 years ago.
1) Ms Pamela Smith is looking to retire in a few years time and in the meantime would like to scale back her involvement with the business. From time to time the business has received approaches from potential purchasers but Ms Pamela Smith would prefer Pamela Limited to continue to be independent after she retires and be run by the management team and employees who have helped her build the business.
2) A couple of years ago she arranged for the company to issue free shares to all the employees under the government’s Share Incentive Plan (SIP). The result was that Ms Pamela Smith held more than 95% of the company’s single class of ordinary shares and the employees held the remaining shares through the SIP.
3) Valuation of the ordinary shares was agreed with HMRC for those SIP awards. This involved a theoretical calculation of the value of Pamela Limited of £3M based on a multiple of profits, with a large discount for the individual shareholdings being very small, uninfluential minority holdings in an unquoted company.
4) A few weeks ago Ms Pamela Smith converted Pamela Limited into an Employee Ownership Trust (“EOT”) owned company under FA 2014 Schedule 37 rules by selling 70% of the Ordinary shares to the EOT, leaving her with over 25% and the employees holding the balance of the shares.
5) The sale of the 70% holding involved a Sale and Purchase Agreement. (“SPA”) between Ms Pamela Smith and the EOT. The total maximum potential consideration for the sale of the 70% holding was agreed between Ms Pamela Smith and the trustees at £2.8 million based on a multiple of profits but with much of the consideration being deferred and dependent on the generation of future distributable profits and surplus cash after the change to EOT ownership. As a controlling interest was being sold there was no discount, unlike for the earlier SIP awards.
6) Under the SPA £800,000 is payable to Ms Pamela Smith immediately on completion from available cash and distributable profits. The balance of the maximum further potential consideration of £2 million is anticipated to be paid in 5 annual instalments of £400,000 over the next 5 years.
7) These instalments will only be paid, if in the future, the now EOT owned company generates sufficient surplus cash and profits to be able to gift money to the EOT to allow the anticipated instalments to be paid by the EOT to Ms Pamela Smith. If there are not sufficient distributable profits and cash generated in the future some or all of the consideration in excess of £800,000 cannot be paid to Ms Pamela Smith.
8) During the transitional period, while there is outstanding consideration due to Ms Pamela Smith, future profits of the company will be required to fund the paying off by the EOT of the consideration due to Ms Pamela Smith. As a result the potential for employees to receive dividends on their direct shareholdings is limited. But to deepen the employees’ sense of ownership and responsibility, after the conversion to EOT status, direct employee share ownership is being increased by a new issue of free shares under the SIP. But these will be small minority holdings and control will remain with the EOT.
9) In the future after the end of the transitional period when the trust’s obligations to the EOT have been fully discharged and future profits are fully available for shareholders it may then be appropriate to value further SIP share awards on a dividend basis of valuation.
10) But, as the fundamental economic nature of Pamela Limited's business has not changed following the conversion to EOT ownership, while future profits will be needed to fund the EOT’s obligation to Ms Pamela Smith, a valuation based on a multiple of profits continues to be more appropriate with a discount for SIP shares being small uninfluential minority holdings in an unquoted company. However this theoretical valuation of Pamela Limited may also need to take into account, through a deduction (however determined) from the whole company value, for Pamela Limited’s non-contractual obligation to fund the EOT from future profits to allow the EOT to pay the outstanding balance of the consideration to Ms Pamela Smith.