Introduction
When a company sells to an Employee Ownership Trust (EOT), careful attention to valuation is critical. HM Revenue & Customs (HMRC) requires trustees to ensure the purchase consideration does not exceed market value, so as to preserve the tax advantages of the EOT. This note summarises HMRC’s guidance and outlines practical steps to satisfy the valuation requirement.
HMRC’s Valuation Requirement
HMRC states that trustees meet the “prudent person” test if they take steps a reasonably prudent person would take to verify that the consideration does not exceed market value. Typical steps include:
- Obtaining and considering an independent professional opinion on market
value. - Ensuring the opinion is addressed to the trustees, so they have standing to
enforce against the valuer if necessary. - Accepting that the opinion need not be updated immediately before completion,
provided there has been no material change since the report date.
Key Practical Steps
Commission a Valuation Report
- Engage a qualified, independent valuer to prepare a written valuation addressed to the trustees.
- Confirm the valuer understands the HMRC requirement and is prepared to defend the valuation if HMRC queries it.
Trustee Reliance and Oversight
- Trustees may rely on the valuation report unless they have “reasonable
cause to suspect” that material facts are incorrect or incomplete. - If any trustee (for example, a company director) has knowledge of
undisclosed adverse facts, they must ensure these are disclosed to the
valuer before completion.
Warranties and Indemnities in the Sale Agreement
- Include specific warranties that all information provided to the valuer is accurate and complete.
- Provide for an indemnity or purchase price adjustment if undisclosed matters later emerge that materially reduce value.
- Note: since 30 October 2024, it is prudent to assume that EOT sale agreements should mirror trade sale standards for warranties.
Director Confirmation
Obtain a written confirmation from the company’s directors, addressed to the trustees, that they have no undisclosed knowledge likely to affect the valuation adversely.
Repayment and Afordability Considerations
- The market value may command high multiples of earnings (e.g. EBITDA).
- While a robust valuation can be justified, an excessively high purchase price may:
- Impose an unduly burdensome debt on the company and trust
- Demotivate leadership if profits are tied up in debt service
- Trustees should expect a sensible repayment schedule that allows for:
- Ongoing investment and growth
- Profit-sharing with employees
- Debt repayment within a reasonable period (commonly 6-8 years,
seldom exceeding 10 years)
Common Pitfalls and Trustee Complaints
- Post-completion regret: Trustees sometimes feel the company was overvalued
if performance deteriorates. Bear in mind that value is fixed at point of sale and
may fluctuate thereafter. - Choosing a cheap valuer: Inadequate or biased valuations risk HMRC challenge
and potential loss of EOT tax relief. - Insufficient warranties: Failure to secure strong seller warranties leaves
trustees exposed if undisclosed issues surface.
Liability and Risk Allocation
- Only the seller is exposed to EOT debt risk; employees, trustees and directors
incur no personal liability for the debt. - In the event of financial distress, a well-advised seller will work with trustees and
management to agree a rescue or restructuring plan.
Conclusion
To satisfy HMRC’s “prudent person” requirement and safeguard EOT tax benefits:
- Commission an independent, trustee-facing valuation.
- Ensure full disclosure of material facts to the valuer.
- Embed robust warranties and indemnities in the sale agreement.
- Secure director confirmations of no undisclosed adverse information.
- Adopt a realistic repayment plan to maintain business morale and financial
health.
Adherence to these steps will provide trustees with a strong evidential basis for market-value assurance and help avoid subsequent challenges that could jeopardise the EOT’s favourable tax treatment.
