Selling to an Employee Ownership Trust

For business owners exiting in the current environment, one of the key emerging considerations is a sale that helps preserve the business’ ethos, values and, perhaps most importantly, workforce once the deal has gone through.

While attracting a strong valuation is, of course, still a primary concern for outgoing owners, an increasing number are placing greater value on ensuring the business is passed into the hands of a new owner or owners that are sympathetic to its history and the way in which it is run.

While a sale to a well-capitalised third party may bring a higher upfront windfall, such a disposal might put jobs at risk and transform elements of the business that have taken years of hard work to build. For owners at small and medium-sized businesses with a close-knit team, these are likely to be even more pressing concerns.

Given these considerations, it’s no wonder that there has been a rapid increase in the number of businesses sold to Employee Ownership Trusts (EOTs) over recent years. As of June 2023, there were more than 1,400 employee-owned businesses (EOBs) in the UK, up 37 per cent from 12 months earlier. 332 new businesses became employee-owned during the calendar year 2022 alone.

What is an EOT?
Employee Ownership Trusts (EOTs), introduced by the government in 2014, are an ownership model designed to encourage businesses to transfer controlling stakes to their employees. Under this scheme, a trust holds shares on behalf of employees, collectively owning more than 50% of the company. To qualify, the business must be a trading company and not have substantial non-trading assets like cash or land.

EOTs must adhere to specific criteria, including the exclusion of employees with over 5% share value, encompassing all other employees, and ensuring equal treatment for everyone within the trust. While benefits can differ based on factors like tenure, hours worked, and salary, they can't unduly favor certain employees.

The establishment of EOTs aimed to create a transparent framework for equitable employee ownership, successfully increasing its prevalence in the UK. Employee-owned businesses now make up 4% of the country's GDP. They are resilient in economic downturns due to higher employee engagement and loyalty, resulting in superior productivity. This model's benefits have led more companies to consider selling to their employees, creating a positive impact on the UK's economy.

Selling to an EOT
To begin, your company must establish the Employee Ownership Trust (EOT). Frequently, an external private firm is chosen to serve as the EOT's corporate trustee. After the EOT is established, shareholders of the company can transfer their shares to the trust through a share purchase agreement.

Determining a fair market price for the business usually involves the collaboration of an independent professional, and the sale price is pre-agreed. This approach minimises the protracted and often costly negotiations commonly associated with traditional business sales.

Typically, an EOT initiates the payment of only a portion of the full consideration upfront, while the remaining amount is treated as a debt. This debt is subsequently repaid over time using the profits generated by the business after the sale.

An outline of the basic steps:
Selling a business to an Employee Ownership Trust (EOT) is a structured process that involves several key steps:

1. Initial Evaluation: The business owner must assess whether transitioning to employee ownership is the right choice. It's crucial to consider the company's eligibility as a trading entity, as non-trading assets like cash or land can disqualify it from EOT status.

2. EOT Setup: If the decision is to proceed, the EOT is established. An external private company often acts as the EOT's corporate trustee to manage the trust on behalf of employees.

3. Valuation: An independent professional typically determines the fair market price of the business. This valuation helps set the sale price and avoids lengthy and costly negotiations later.

4. Share Sale Agreement: A share purchase agreement is drafted. Shareholders can then sell their shares to the EOT under the agreed terms.

5. Financing Structure: EOTs usually pay only a portion of the sale price upfront. The remaining amount becomes a debt, paid off over time using the business's post-sale profits.

6. Employee Engagement: Communicate the transition to employees, explaining the benefits and their role in the new ownership structure. Ensure a clear understanding and buy-in from the workforce.

7. Legal and Regulatory Compliance: Comply with all legal and regulatory requirements related to the sale and EOT structure. This may include filing necessary documents with relevant authorities.

8. Transition Period: The previous owners often remain involved for a transition period to provide guidance and ensure a smooth shift in ownership and management.

9. Governance Structure: Establish a governance structure for the EOT, which may include an employee council or board of directors to make strategic decisions.

10. Monitoring and Support: Regularly monitor the EOT's performance and provide support to ensure its success as an employee-owned business.

This process not only promotes equitable employee ownership but also facilitates a smoother transition while benefiting both the business owner and the employees. Legal and financial advice is essential to navigate the complexities involved in selling to an EOT.

In our next edition, we will examine some of the key advantages of selling to an EOT, as well as some of the challenges that the process might pose.