Understandings are guidance notes issued by the Employee Share Ownership Centre following discussions with governmental and regulatory bodies.
Share Valuations Worked Examples Group
The Centre is the secretary to the Share Valuations Worked Examples Group (WEG). Worked examples agreed with HMRC appear here as Understandings, may be disseminated by WEG members and will be published by HMRC in due course.
Share Valuation Worked Example 1
Public Service Mutual Healthcare CIC (“Healthcare CIC”)
Healthcare CIC is an employee-owned community interest company.
Healthcare CIC’s share capital comprises redeemable ordinary shares of £1 each (each a Partnership Share) and one ordinary (non-redeemable) share of £1.
Shares may only be held by employees. Each permanent employee may subscribe for one Partnership Share for £1.
Each share carries one vote. In practice no dividends are paid and if they were they would be subject to the dividend restrictions in the Community Interest Company Regulations 2005.
If a holder of a Partnership Share ceases to be an employee of Healthcare CIC then their share is redeemed for £1.
The ordinary (non-redeemable) share is the same as a Partnership Share except that it is non-redeemable and must be held only by an executive director.
There are numerous issued shares and each shareholder has a very small insignificant minority shareholding.
The Actual Market Value of each share in Healthcare CIC is £1.
It is unusual in private company share valuations for the Actual Market Value and the Unrestricted Market Value to be the same but, in the particular circumstances of this example, the Unrestricted Market Value may also be taken as £1.
Share Valuation Worked Example 2
EOT owned company (“Pamela Ltd”)
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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
Experts may submit worked examples to email@example.com.
Issued by the Esop Centre on January 12 2017
There has been increasing interest in the employee ownership business model in recent years, in particular since 2014 when the government introduced significant new tax reliefs to encourage companies to become majority or wholly owned by Employee Ownership Trusts (EOTs).
However, leading members of the Esop Centre have been concerned that accountants might not immediately appreciate the fundamental difference between an EOT and the type of Employee Share Ownership Plan trust (ESOP trust) which has been traditionally used to warehouse shares for direct employee equity participation.
Under UITF38, ESOP trusts were treated in the accounts as an extension of the company, in what was sometimes called the “extended equity” method of accounting. UITF38 has now been replaced by new rules for intermediate payment arrangements in FRS102; this contains a rebuttal presumption that the extended equity method applies to ESOPs (and other similar intermediary payment arrangements).
In conjunction with William Franklin of Pett, Franklin & Co. LLP and Graeme Nuttall OBE of Fieldfisher LLP, the Esop Centre discussed the issue with staff at the Financial Reporting Council (FRC). Following those discussions, it is our understanding that, when an EOT owns shares in a company, the presumption that extended equity accounting applies can be rebutted because, unlike an ESOP trust, an EOT is part of the company’s ownership and governance structure and is designed to operate alongside or independently of the board of the sponsoring company.
New section 9.33A in FRS 102:
(Additional commentary added on June 4 2018).
It is possible for an entity to be owned by a trust established for the beneﬁt of employees without the entity controlling the trust. An example is when the entity is a co-operative, owned by its employees, and all of the shares are held in a trust for the beneﬁt of the employees but the shares never vest in individual employees, with dividends from the company being distributed to employees solely in accordance with the provisions of the trust deed
Revision not mandatory till 2019 but can be referred to – FRC.