The rise and rise of the Employee Ownership Trust (EOT)

The number of companies being sold from private ownership into the hands of their employees, via the use of Employee Ownership Trusts (EOTs), continues to increase.  

There has been much in the media over the past few years around the increasing popularity in the use of EOTs and there is no slowing in the rate at which sales to EOTs are happening.

According to the Employee Ownership Association, 1 in every 20 private company sales (as compared to trade sales and sales to private equity) was to an EOT, as at January 2021.

In fact, at the time of writing there are thought to be over 600 EOT owned businesses in existence in the UK, with HMRC data suggesting that many more are likely to follow.

The chart below shows how the number of EOTs has increased over the past 8 years – and the rate of increase shows no signs of letting up.

The EOT structure enables business owners to sell a controlling stake in their company to an EOT in exchange for the seller receiving full market value for their shares.

The EOT is operated by trustees, and the beneficiaries of the EOT are the employees of the company at any given time.

One of the key benefits for the seller is that, provided the relevant conditions are met, the proceeds that they receive for their shares upon a sale to an EOT can be received entirely tax free.

There are benefits for the employees too. The EOT structure enables employees to receive tax free bonuses each year of up to £3,600. In addition, research has shown that EOT owned businesses can be more productive and profitable as a result of increased employee engagement.

The tax rules mean that to obtain the tax free sale, the EOT must acquire a “controlling stake” in the business (i.e. more than 50%), however, the owner can still remain engaged with the business – in fact they can remain a full time employee and receive a commercial salary for their role whilst they remain employed.

A common EOT based exit strategy sees the owner receiving a share of their consideration on day 1, with the balance of the funds then taken over a period of time (known as “deferred consideration”).

This deferred consideration could be paid using the future profits of the trade (known as “vendor finance”), or by the EOT borrowing funds externally, for instance, from a bank.

Assuming there is some element of deferred consideration, the owner would have a vested interest to remain actively involved with the business following sale.

They will, of course, want to see that they receive their full consideration in a suitable timeframe. In addition, their presence can ensure that the stakeholders of the business, in particular the employees who will be responsible for running it, are well prepared to take it forward post-departure, as it may be the case that they do not come from a management role or they might not feel that they have the commercial experience required of a business owner at the point of sale.

Whilst the generous tax incentives remain, we anticipate to see continued increase in the popularity of EOTs, and data suggests that more and more EOT related clearance applications are landing on HMRC’s doormat each month. It will, of course, be interesting to see whether the increased attention that EOTs are receiving will result in HMRC looking to restrict some the generous tax reliefs that they currently offer.

EOTs are well suited to scenarios where there may not be a traditional exit route, such as a sale to a third party or a management buyout (MBO). This may become even more relevant in the coming months if the UK slips into a recession and a possible downturn in activity within the M&A market as is predicted by many. If you have questions you can get in touch using the button below.