How the Money Works in an EOT Transaction

When business owners consider exiting their company to employees, one of the biggest questions we get is “how does the money really work in these transactions?” Many owners are interested in Employee Ownership Trusts (EOTs) because they balance the simplicity of a direct sale to employees while requiring less cash from employees and avoiding the complexity of an ESOP. This article provides an overview of how EOT transactions are structured and financed.

There are four key components we put in place to ensure successful, balanced transactions:

1. The Employee Ownership Trust: The trust agreement between selling owners, employees (especially key leaders), and the company about how the company will be managed going forward. It also ensures long-term stability in management and governance through built-in succession planning, providing confidence to investors and banks. 
   

2. Transaction Plan: Structures owner payout - both upfront, and over time. As owners’ risk is reduced through a payout plan, employees get an increasing share of company profits, aligning incentives for success. If the company does well, employees and owners both benefit. Owners are also protected on the downside and everyone is shielded from undue liability.
   

3. Waterfall Agreement: Customizes deal terms to ensure that the company’s capital is used to serve the goals of the transaction. This “waterfall” is a premade agreement about who gets paid in what order. This secures owner payouts while enabling future growth for the company and employees. This alignment also provides an opportunity for charitable owners to install long-term charitable contributions.
   

4. Long-Term Upside Protection: While optional, we recommend owners hold at least 10% equity long-term so they can benefit from major successes, while being largely de-risked.
   

Where does the funding for an EOT buyout come from?

There are two main types of financing used in EOT transactions - external and internal sources.‍

External Financing:

• Bank Loans - Typically the most accessible and least expensive debt financing option. Banks will lend based on company assets, historical cash flows, and projections. Best for stable companies with hard assets as collateral. 
  

• Mezzanine Debt - Higher interest rate debt that sits between loans and equity in the capital structure. Terms vary, but Mezzanine debt is can include more flexible terms including various options for repayment (ie. can be paid interest only for a time, can be paid later all at once, or paid partially in equity), so can in some cases be aligned with an employee ownership transition.
  

• Third Party Silent Equity - Individual investors, private firms, and community organizations can sometimes provide equity capital without taking a controlling position. Investors get potential upside through equity growth and a future repurchase of equity, sitting alongside employees and owners who choose to hold equity longer-term. Benefits include flexible terms without interfering in operations or requiring the company to be flipped.
  

• Vendor Financing - Effectively a payment plan direct from equipment vendors, contractors, or other service providers as part of contract. This is less common, but often has very beneficial terms. This can be a valuable source of financing to consider if your company has one or more key vendors who rely on you in a supply chain, and may be willing to invest in order to ensure your company’s continued operations as a customer.
  

Internal Financing:

• Seller Notes - The selling owner “finances” part or all of the transaction price, paid back over an agreed timeline. Usually this takes the form of a debt note or “earn-out” (a kind of guaranteed earnings sharing agreement) with the company. Benefits include simplicity, and aligned incentives in growth. 
  

• Company Share Buybacks - Rather than dividends or bonuses, profitable companies can use reserves to repurchase shares from owners over time. Adds flexibility to cash deployment. Allows owners to de-risk while still participating in upside, and spread taxation out over a longer period of time.
  

• Balance Sheet Cash - Using existing company cash reserves to pay out owners. Best for companies with meaningful cash reserves, or for closing gaps in external financing. Stresses balance sheet much less than debt.
  

• Direct Employee Share Purchases - Employees invest personal capital to buy shares directly. Increases commitment and motivation. Good supplementary option but cannot usually fully finance larger transactions.
  

What Does a Typical Transaction Look Like?

While an EOT transaction can be extremely customized based on the owner and company’s situations, there are a few common structures we see for typical EOT transactions:
‍1. Balanced Split Transaction: This structure splits the sources of funds evenly across external debt, internal reserves, and deferred owner payment over time. It reduces risk for all parties.

Example capital stack:

• 34% External Debt Financing
• 33% Internal Cash Sources
• 33% Long-Term Seller Note
  

2 .Majority External Financing: For companies with strong assets and balance sheets, the majority of funds can come from bank lending, with smaller portions from internal sources and long-term owner financing.

Example capital stack:

• 60% Bank Loans
• 30% Seller Note 
• 10% Long-term hold‍

3. 100% Seller Financing: The entire transaction value can be financed by the selling owner if desired. This allows for a very simple structure without external debt or employees required to put up cash.

Example capital stack: 

• 100% Payout to Owner Over Time
  

These are just a few examples of how typical transactions are structured. With the Common Trust team's guidance, we can customize the optimal blend of financing sources and payout timeline for each company and owner based on their unique situation and goals.

Conclusion

Exiting a business is one of the most significant decisions an owner will make. From balancing personal financial priorities to protecting employee livelihoods and your legacy, the stakes are high. We know 75% of business owners regret their exit decision within a year of completion. This further emphasizes the need to thoroughly explore all options during exit planning.

Unlike the risky nature of private equity buyouts that can disrupt operations or ESOP complexity that may inadvertently incentivize employees to leave over time, our EOT model provides built-in employee retention and transition. This empowers your organization and community to flourish for generations while reducing risk through diversified employee succession and structured payout terms.

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