Employee Ownership Trusts (EOTs) – lessons learned, 10 years on
20/10/2025
Employee Ownership Trusts first became available in 2014. After a slow start, with fewer than 500 EOTs estimated in 2019, they are growing in popularity, and there are now estimated to be more than 2,000. Now is therefore a good time to consider what lessons have been learned.
Is the business a good fit for a sale to an EOT?
One size does not fit all, but the first consideration should be whether the business is suited to an EOT transition, including:
The current structure and ownership base
If the current business is not operated through a company, a reorganisation will be required, adding to complexity and fees. There will need to be consensus among the current shareholder base or, failing that, clear rights enabling delivery of the transaction.
The senior management team
How well will the board and senior management team operate after EOT transition (with or without the sellers’ involvement)? Are they committed for the long-term and have they responded positively to the EOT proposal?
Are the financial projections for the business reliable?
Sustainable profits will be needed to pay the (often significant) deferred consideration. The management team and employees will want there to be a realistic prospect of some, if not full, tax fee bonuses being paid (currently capped at £3,600 per employee).
Is there agreement on valuation?
There are now legal requirements relating to the purchase price not exceeding market value. But to ensure the long-term success of an EOT (and increase the likelihood of the sellers being paid in full), inflated valuations (which might still be held out as representing market value) should be avoided.
The size of the workforce
EOTs are not generally considered appropriate for companies with only a handful of employees. At the other end of the scale, tax-free bonuses are intended to be paid to all employees (subject to permitted variations). So, if there are a large number of employees, are meaningful bonuses for the whole workforce a realistic possibility?
Are there viable, more suitable, alternatives to a sale to an EOT?
Open discussions should take place with the senior management team to establish their appetite for viable alternatives, such as a management buy-out or EMI share options (leading to a potential trade sale or MBO). While these will not deliver the tax benefit of a full exemption from CGT for the sellers, they may provide or lead to a more viable exit for sellers if the management team does not support an EOT proposal.
What professional advice is needed?
Tax advice
The significant tax benefits available to sellers to an EOT (no capital gains tax on the sale) can now be lost if any one of a number of conditions is not met for the first 4 years after a sale to an EOT. Expert tax advice is therefore essential and the tax adviser will also be expected to apply for relevant tax clearances.
Professional valuation
As mentioned above, there is a need for an independent valuation to be obtained. This should be addressed to the buyer (usually the corporate trustee of the EOT) so that they can rely on it. Consideration should be given to obtaining two valuations to help the parties reach agreement on the purchase price.
Independent trustee
It is common (if not expected) for an independent director to be appointed to the board of the corporate trustee (often taking their place alongside one or perhaps two employee representative director(s) and a seller representative director). It would be helpful for that person to have a strong commercial, financial and/or professional advisory background. This person may commonly take the lead in reviewing and commenting on the sale and purchase documentation for the buyer side.
Legal advice
Some sellers to EOTs are advised that an EOT transaction can be completed with the involvement of a single law firm engaged by the trading/target company. That may result in a stress-free transaction and lower professional fees, but neither the buyer nor the seller will be meaningfully advised on:
- material areas of concern which merit due diligence;
- charges or guarantees to secure deferred consideration;
- interest on deferred or late payments;
- warranties and indemnities (and related disclosure); or
- limitations of liability.
Ensuring full advice is taken by all parties on such material issues is more likely to lead to a balanced overall position and to more positive, open communication between relevant parties. This should bolster trust and may help deliver stronger business performance under EOT ownership (and reduce possible resentment in difficult times). It should also protect the principals if their actions are ever questioned in the event of business failure.
The most cost-effective set up is for the firm advising the trading/target company on establishing the EOT to extend their engagement to advise the corporate trustee on the acquisition. This should ideally be agreed at the outset.
Heads of terms
With agreement in principle on a sale to an EOT and an advisory team in place, heads of terms should be prepared. This should save costs in the long run. The heads of terms will ideally cover:
- anticipated price or price range (even if to be reconfirmed nearer to completion);
- allocation between completion and deferred payments (including payment schedule and interest, if any, on deferred payments);
- whether any shares are to be retained by existing shareholders (noting that the EOT must be in majority control) and, if so, any related commercial terms;
- security for deferred consideration (if any) and its expected form;
- composition of the boards of the trading/target company and the corporate trustee (and whether an employee council is to be set up, which would elect employee representative director(s)); and
- scope of warranties and indemnities (and whether a tax deed of indemnity/tax covenant is proposed).
Timetable and communication plan
A detailed timetable and communication plan should be prepared early on, with careful thought being given to when employees are told about the transaction. While such a communication might be delayed until after a valuation has been obtained and the preliminary purchase price and heads of terms have been agreed in principle, it should be made in good time before the sale takes place, so that the employees can ask questions and feel included in the process. In one published article about an EOT going into financial difficulty, the employees were not told about the deal until after it had completed, which cannot have helped get things off to a positive start!
This article is not legal advice, which it may be sensible to obtain before you take any decisions or actions in the areas covered. Please do contact me if you would like an initial discussion of your situation.
