Why Employee Ownership Trusts (EOT) are an Essential Option for SMEs

At Boardroom Advisors, we work extensively with entrepreneurs and business owners. That means we understand that for those people, their bottom line isn’t always the bottom line. They care about the long-term future of their businesses and the legacy they leave when they move on.

Such considerations come into stark focus when it comes to succession planning. Company founders want a particular type of succession. They want an option that secures their financial future and that of their business. Employee Ownership Trusts (EOTs) are becoming increasingly popular for that very reason.

What is an EOT & How Does it Work?

An EOT is a model for business ownership. By establishing the special type of trust, an entrepreneur or founder can transfer ownership of a firm to its employees. This has been an option for small business succession since 2014. It was then that the UK government first introduced EOTs.

In this model of ownership, it’s the trust that owns the company. The company’s employees, though, get a say in the running of the business. Profits generated by the firm, too, get distributed equitably amongst the staff. That’s once the trust has finished paying the agreed-upon price for the company to the outgoing owner.

The beauty of EOTs is that they make it simpler to transfer a company to employee ownership. The outgoing owner gets bought out gradually over time. Their sale price comes bit-by-bit from the company’s future profits. Employees, therefore, don’t need to find the finance to buy the company outright. That’s something that would be well beyond most workforces, and what separates EOT from a Management Buy-Out (MBO).

How Employee Ownership compares with other options

How Employee Ownership compares with other options

Download the EOT Comparison PDF

How to Manage Your Succession Via an EOT

It’s easier than you may think to sell a company to an EOT. In fact, the straightforward nature of the process is one of its key advantages. If you want to manage your succession from a business through the EOT route, you need to do the following:

    1. Establish an EOT with an appointed set of trustees. 
    2. Engage an independent third-party to provide a valuation of the business.
    3. Sell your shares – or at least 51% of the total shares – to the EOT through a share purchase agreement.
    4. The purchase price remains outstanding and produces a debt owed to the outgoing owner by the EOT.
    5. The business pays off the debt with annual contributions from its trading profits. 
    6. Once each annual contribution gets paid, any remaining profit gets shared between company employees. 
    7. Eventually, the outgoing owner receives the full, agreed purchase price. The EOT then wholly owns the company.
    8. All future profits get equitably distributed between the company’s employees. 
    9. It is strongly recommended to appoint Advisors to help with the transition of the business from owner-managed to employee-owned. Boardroom Advisors can assist, get in touch.

Conditions to Meet to Set Up an EOT

The above is a fair reflection of the process involved in setting up an EOT. As an HMRC-approved scheme, however, there are some further rules attached. Before you begin a sale to an EOT, you must make a submission to HMRC. That’s to prove that your EOT will meet their qualifying conditions:

    • At least 51% of shares must get sold to the EOT. Essentially, the trust must have a controlling stake in the company. Outgoing owners, therefore, can retain some shares (up to 49%) if they desire.
    • There must be a ‘broadly equitable’ distribution of profits to employees under the EOT. That doesn’t mean all employees must get the same amount. What’s paid can vary according to salary, hours worked, or years’ service. It can’t, however, get decided by performance.
    • The price paid to an outgoing owner must get agreed upon by an independent valuation. 

There are other HMRC-imposed rules, too, but the above are the principal examples.

Advantages of an EOT for an Outgoing Owner

Succession via an EOT holds benefits for many of the parties involved. Some of the most significant advantages for an outgoing owner are as follows:

    • Tax Free – Instead of Entrepreneurs’ Relief (currently 10%), EOT is tax-free at time of writing. While it is never recommended to do something just for a tax benefit, this is not to be sneezed at, as it can save the owner £100,000 on every £1m of sale value.
    • Speed & Simplicity – Setting up an EOT allows an owner to exit the stage on their own timeframe. They don’t need to secure a favoured investor, nor do they need to do as much due diligence. 
    • Price – Outgoing owners will get the company’s full market value as defined by an independent valuer.  The only stipulation is that it gets paid incrementally over time. Payments from the EOT to old owners, though, are tax-free. 
    • Legacy – By selling to an EOT, an owner can retain greater control over the firm’s future. They know the new owners of the company intimately, as they’re their employees. What’s more, it’s possible to stipulate the ongoing culture and values of the business.
    • Cost & Flexibility – Succession costs get reduced by the lack of extensive negotiations and due diligence. Owners also have the flexibility to retain up to 49% of shares if they desire.   

Benefits of an EOT for the Company & its Employees

The EOT avenue for succession doesn’t only offer advantages for outgoing owners. There are also some notable benefits for the company and its employees, as it enters a new phase of existence:

    • Tax Benefits – there are considerable tax benefits for employees at part of the EOT.
    • Continuity – Employees can be assured of stability in the time following the sale. They don’t have to worry about a new owner stripping the firm’s assets or otherwise endangering their jobs.
    • Employee Engagement – As shareholders in the company, employees have a greater interest in the firm’s success. They’re likely to be more engaged and productive as a result.
    • Higher Staff Satisfaction – Employees enjoy having a say in the running of a business. They also appreciate annual bonuses, especially those that are tax-free up to £3,600.  

Drawbacks of Succession Via EOTs

No business decision is without its potential drawbacks. The following are some of the possible issues of choosing a succession plan based on the EOT model:

    • Not Best Possible Price – In a trade sale, an owner may be able to negotiate a price above the present market value for their shares. This isn’t possible when selling to an EOT.
    • FOMO – By deferring receipt of payment for your shares, you may miss out on the full price. If the business fails before the EOT’s debt to you gets paid, you might not be able to recoup what you’re owed. 

Conclusion

Employee ownership is an increasingly popular business model. Although not technically an EOT, the likes of John Lewis have shown how successful it can be. Aardman Animations and Richer Sounds have followed the EOT path. The UK government, too, is keen on the idea. That’s why they introduced EOTs and made EOT payments to outgoing owners tax-free.

You should now understand the ins and outs of EOT. You know how they work, if they’re right for your business, and how to get started. The rest is up to you.  

Written by: John Courtney

John is highly ranked in the Top 100 UK Entrepreneurs list by City AM and is winner of the Lifetime Achievement Award from techSPARK. He has been a Board Director himself for over 40 years and first started placing Non-Executive Directors over 25 years ago. John founded and ran six of his own businesses including a Management Consultancy for 10 years, a Corporate Finance offering for 10 years and a mid-sized Digital Agency for another 10 years.