One of the biggest misconceptions about Employee Ownership Trusts is that the valuation is simply whatever the seller and the trustees agree. It is not. The legislation requires something more objective: the trust must acquire the shares for market value, and the trustees must take all reasonable steps to ensure they do not pay more than market value. Those two requirements shape almost every EOT transaction.
Market value is not negotiated value
For tax purposes, the starting point is the statutory definition of market value in the Taxation of Chargeable Gains Act 1992. In simple terms, market value is the price the shares might reasonably be expected to fetch if sold on the open market between a willing buyer and a willing seller.
It is not simply the figure the seller would like to receive. Nor is it necessarily the figure a trade buyer might pay after allowing for synergies or strategic value. An EOT is not purchasing strategic control in the way a trade buyer might, so the valuation needs to reflect the market value of the shares themselves rather than the ambitions of a particular purchaser.
The trustees have their own responsibilities
The trustees are buyers. That matters. Their role is not simply to approve the seller's valuation — they must independently satisfy themselves that the consideration represents market value.
The legislation requires trustees to take all reasonable steps to ensure they do not pay more than market value. What amounts to reasonable steps depends on the circumstances, but in practice trustees will normally rely on professional valuation advice alongside a proper understanding of the assumptions made. Simply accepting the seller's preferred figure is unlikely to be sufficient.
How businesses are usually valued
Most trading companies are valued using one or more well-established methodologies.
Earnings multiples
This is the approach most commonly seen in profitable trading businesses. Maintainable earnings are identified and an appropriate multiple applied, having regard to the company's sector, size, growth prospects and risk profile. Small changes in either the earnings calculation or the multiple can produce significantly different valuations — understanding those assumptions is often more important than the arithmetic.
Discounted cash flow
Where future cash flows can be forecast with reasonable confidence, a discounted cash flow model may be appropriate. This is seen more frequently in larger businesses, or businesses with predictable long-term cash generation. The quality of the assumptions is critical: small changes to discount rates or growth assumptions can materially affect value.
Net asset value
Some businesses are worth more for what they own than for what they earn. Property companies, investment businesses and certain asset-rich companies often require an asset-based approach. For many trading companies, however, net asset value provides only a useful cross-check rather than the primary valuation.
There is rarely only one answer
Valuation is not an exact science. Reasonable experts may legitimately arrive at slightly different conclusions. The important question is not whether there is only one correct number — it is whether the trustees can demonstrate that the price paid falls within a reasonable range supported by proper evidence.
Affordability and value are different questions
One of the most important distinctions in an EOT transaction is the difference between value and affordability. The company may be worth £20 million. That does not automatically mean the trust should agree to pay £20 million. If the company cannot comfortably generate the cash needed to fund the deferred consideration, the transaction may simply be unaffordable.
The valuation establishes what the shares are worth. The funding model determines what can realistically be paid, and over what period. The two conversations should inform each other, but they are not the same conversation. Our guide Funding an EOT sets out where the money actually comes from.
The best valuation is one everyone understands
A valuation should never feel like a mysterious spreadsheet produced by an expert. The trustees should understand the principal assumptions. The sellers should understand why adjustments have been made. The directors should understand how the repayment profile interacts with future cash generation.
When everyone understands the valuation, negotiations become considerably easier. When nobody understands it, disagreements usually follow. If you would like the valuation for your business explained rather than simply delivered, start a conversation.