What happens when an employee-owned business is sold?

This article has been cowritten by James McBain Allan from Bishopsgate Corporate Finance.

The purists would say that once a business transitions to being employee owned, it must stay that way. An alternative view, and one that is increasingly reflected in practice, is that an employee ownership model is not always in the interest of the long-term prosperity of the business, and that a different ownership structure could open up development opportunities which would not otherwise be available.

Geldards has advised three employee-owned trusts on the sale of their trading companies to both trade and private equity backed acquirers and anticipates there will be more transactions where the circumstances are right. Those circumstances are worth understanding in detail, because they shape both the legal and commercial approach to any such transaction.

When does a sale make sense?

The reasons why it would make sense for an employee-owned business to be sold are numerous. The following circumstances are among the most common, though they are not exhaustive.

1.  The next transaction has a positive impact on the long-term growth prospects for the business. This is a critical consideration for the directors who sit on the board of the EOT. They must believe the decision to sell is in the best interests of the employees, the long-term prosperity of the business, and its ability to keep employees employed.

2.  The business operates in a market going through significant change. A founder’s appetite for risk can be far greater than that of a management team who have not risked everything to build the business. Securing third-party funding to shore up the business’s defences may not be possible without directors being willing to give personal guarantees — a significant ask in the context of an employee-owned structure. A different ownership model may give the business better access to development capital.

Even if the above circumstances exist, the timing of a sale will be strongly influenced by:

1.  The end of the 4-year clawback period during which time additional capital gains tax would become payable by the sellers on the value of the original transaction. The sellers would normally have a veto right on any sale during this period, so if this period has lapsed, a sale is more likely to go through.

2.   Whether the numbers would stack up. If the deferred consideration owing to the sellers has either been paid or is being serviced by the business easily. The amount of outstanding deferred consideration may impact the valuation of the business for the next transaction. If there has been no growth in value between the date of the original transition and the next transaction, the economics of the deal may not work — the EOT will be liable for capital gains tax crystallising on the sale, and the purchase price must be at least sufficient to cover that tax, the outstanding deferred consideration, and the associated costs of sale.

3.   Sufficient time has elapsed since the  share incentive scheme for the senior management team was established in order that it will provide a pay out on the sale for the senior team .The introduction of share incentive schemes after transition to an employee-owned structure is now quite common. It enables the business to attract and retain senior talent – which, in turn, will be attractive to a prospective buyer.

The legal landscape

The legal aspects of selling an EOT-owned business are broadly similar to a sale of a privately owned business, but there are important differences. How the proceeds of sale are allocated, and how the trustee board discharges its duties to the beneficiaries of the trust, are just two of the considerations that require careful attention. These are not administrative details, they are substantive obligations that shape how any transaction must be structured and documented. The provision of warranties and indemnities will be a key point for a buyer. Warranty and indemnity insurance may be required as EOT trustees will not give commercial warranties or indemnities.

The role of an M&A advisor

Once the legal and commercial conditions are in place, the next question is straightforward: who buys the business, and how do you find them? This is where most management teams and trustee boards reach the edge of their experience – and where the absence of professional advice is most costly.

A key part of that role is ensuring the right buyer is found for all stakeholders, not just the management team seeking equity, but the trustee board fulfilling its duties to employees, and the sellers still owed deferred consideration. The right buyer for one party is not always the right buyer for all of them and navigating that tension is where experienced advice makes the difference. Who are the right buyers:

1.     Private equity: backing the management team

PE is an increasingly natural home for former EOTs, particularly where a strong management team is already in place. Key considerations:

• Real equity for the first time. A PE deal typically gives senior managers direct ownership — not a trust share or bonus scheme — with genuine upside at the next exit.
• Fit matters as much as price. Sector focus, fund size, appetite to back incumbent management and cultural alignment all determine whether a deal actually works for the business.
• The market is large and easy to navigate badly. Without guidance it is straightforward to approach the wrong funds or miss the right ones entirely.
• Management equity must be structured carefully. The difference between a well-structured package and a poorly structured one can be the difference between meaningful upside and finding leaver provisions or dilution working against you.

2.     International trade buyers: paying a strategic premium

A strategic acquirer entering the UK market, or looking to acquire capability quickly, will often pay a premium a financial buyer cannot justify. But international processes require specific expertise:

• The EOT structure is not well understood internationally. Buyers in North America, continental Europe or Asia-Pacific need it explained – and approached through the right channels.
• Relationships open doors that cold approaches do not. Corporate development teams at international acquirers rarely engage without existing sector credibility or a warm introduction.
• Cross-border deals add complexity. Currency, jurisdiction, regulatory approvals and cultural considerations all require active management throughout the process.

Why process is everything

The single biggest driver of outcome — for the EOT, for employees and for management — is running a competitive process. A buyer who knows they are competing behaves differently to one who believes they are the only option on the table. For trustee boards with a legal duty to act in the interests of employees, a properly run process also provides documented assurance that the best available terms were achieved — protection that matters if decisions are ever scrutinised.

A final thought

Selling an EOT-owned business is not the same as selling a privately owned one. The stakeholder dynamics are more complex, the trustee duties are real and enforceable, and the range of potential buyers is wide. Getting the right legal and commercial advice working in tandem is not a luxury — it is how good outcomes happen.

For more information

For legal advice on becoming employee owned or selling an employee-owned business, contact Debra Martin at Geldards LLP: debra.martin@geldards.com

For M&A advisory on finding the right buyer and running the right process, contact James McBain Allan at Bishopsgate Corporate Finance: jamesma@bishopsgatecf.co.uk