After over 4 months as a trainee solicitor in the corporate team at Geldards I have been fortunate enough to sit in on a number of initial client meetings with business owners considering a transition of their business to employee ownership through an Employee Ownership Trust (EOT). Whilst sitting in on these meetings I have been able to listen to some of the most pivotal conversations business owners have about their company’s future giving a real-time glimpse into the legal, commercial and human decision-making that goes into business succession.

In this article I will explore what an EOT is and share my insights gained from attending initial client meetings on when an EOT can be an effective succession plan – and when it may not be the right fit for a business and/or the business owners.

What is an EOT?

An EOT is a trust that allows a business to be owned on behalf of its employees.

An EOT works by:

1. The shares in the company being sold to the EOT

• The shareholders of the company sell at least 51% (more commonly 100%) of their shares and voting rights to the EOT.
• The shares are paid for by a contribution from the trading company. The contribution can be made from cash reserves to pay any initial consideration with deferred consideration being funded from future profits contributed to the EOT.

 2. The EOT becoming the new owner of the business

• The trust will hold the shares in the company for the benefit of the employees.
• The company will continue to run as usual as the EOT doesn’t manage the day-to-day operations of the company – the EOT’s role is to simply ensure that the company is run for the benefit of the employees.

3. The employees benefit

The employees do not have a direct shareholding so there is no requirement to purchase shares from employees when they leave the company. However, they do benefit from the success of the business through income tax free annual bonuses.

Listening to the “Why” – Understanding the Client’s Motivations

Whilst attending initial meetings with business owners the main point of discussion was seemingly simple on the surface – “Is an EOT right for us?”. The conversations that were had were not merely about business structure and tax benefits; they were also about values. Business owners want to know if an EOT is possible, but also if it is right for their business, their employees, and their hopes for the business long-term.

In these meetings, I have noticed that certain aspects of EOTs strongly appeal to business owners, while others raise challenges that can lead them to reconsider whether an EOT is the right fit for their business.

Is an EOT right for the business?

The Appeal of EOTs to Business Owners

• Tax benefits – the selling shareholder(s) benefit from a Capital Gains Tax free disposal where the shares are sold in the same tax year in which the EOT obtains control. This is a significant saving compared to a trade sale outside the EOT model.
• Cultural preservation/continuity – business owners often hesitate to sell their company because they want to safeguard what they have built – the people, values and culture that define their business. Selling to an EOT offers a way to maintain continuity, allowing the company to continue operating as it has. For many business owners, an EOT is seen as a means of protecting the business’ ethos that they have worked hard to establish.
• Employee reward – income tax free annual bonuses for employees of up to £3,600.
• Employee morale and retention – employees do not have the concern of job insecurity after a sale to an EOT compared to a trade sale where there may be job duplication and costs savings to be made.
• Avoid trade sale pressures – a sale to a third party can be time consuming and even contentious. An EOT sale is considered more friendly although legal advice should still be obtained for the EOT and the sellers.

The Challenges of EOTs to Business Owners

• Financing the sale – an EOT typically relies on the company’s current capital and future profits to pay the former business owner. The amount of capital taken out of the business can create pressure on the business’ clash flow and in addition relying on deferred consideration can mean that the business owner(s) have to wait several years to receive the full value for their business.
• Loss of control – for many business owners, stepping away from operational control of the company can be difficult. An EOT often requires the appointment of independent trustees and a shift in the decision-making authority. Business owners need to be ready and willing to let go of control, at least at the shareholder level, while ensuring the leadership team is capable of continuing the business successfully.
• Employee engagement – for an EOT to succeed the business often needs to invest in internal communication and culture change to help employees understand what being an EOT means. EOTs work best when employees understand and embrace the fact that the business is employee-owned.
• Sustainability of the business model – the long-term success of an EOT hinges on the continued health and profitability of the business. If the company underperforms post-sale, it may struggle to meet its obligations to the seller.
• Suitability – a sale to an EOT often results in a lower upfront payout to the business owners (although tax relief can help mitigate this). As such, an EOT may not be suitable for owners who require immediate liquidity. Our team can assist with alternative succession options if an EOT is not the correct fit for your business.

How we can help

If you’re a business owner exploring succession options and think an Employee Ownership Trust might be the right fit, our team at Geldards is here to help. We offer clear, commercially focused advice at every stage – from assessing suitability and structuring the transition, to establishing the trust and guiding employee communications.