EOTs – the way ahead beyond the pandemic?

There has been a growth in the use of Employee Ownership Trusts (EOTs); the pandemic has made them much more relevant and they should be considered as a viable exit strategy.

For some sectors the pandemic has had a dramatic effect on a business’s valuation and what a buyer may pay now will inevitably be affected by what could happen again, so a straight sale might not realise its proper value.

With an EOT, the owner can receive some payment now, hand over the business to a team they know and trust and realise the rest of the value over a longer period, they can also continue to be involved in the business.

For instance, I’m working on one at the moment for a travel firm – it couldn’t possibly attract a reasonable price if it went to market now, but when the restrictions lift and confidence returns, so will its value. Under an EOT, the seller will receive some retained cash, deferred payments generated out of future cash flow and a contingent element linked to how the business trades.

The deal costs, due diligence and disruption to the business will be reduced. The EOT has to pay the market rate, but it is a deal involving employees who know about the business, so the normal due diligence requirements should be reduced along with the funding needs, as the consideration is often generated from the company’s retained cash reserves and future earnings.

For owners who know that they want an exit and might not have the energy to drive it forward, they can use EOTs to move on and hand over the reins to their trusted team. The model is tried and tested, and research supports employee ownership as providing a “win-win business model”; good for the business and good for the employees. In my experience, many owners also want to preserve what may be a lifetime’s work and to look after their staff, and an EOT enables them to embed the values and ethos of the business in the structure.

The recent changes to Entrepreneurs’ Relief and the available CGT exemption, as well as the expectation that in order to pay for the pandemic, tax rates on businesses will increase, make an EOT an attractive option. It should not be pursued solely for the tax saving, of course – the employees must want to do it and be willing to step forward. It also needs to be seen as a settled position – the tax legislation provides a clear disincentive for an EOT to be then sold on.

Conversely, an EOT might not be the best place for a really driven and entrepreneurial leader, because, whilst the trading company can continue to pay market rate salaries and bonuses, there is little scope to create value by holding an equity interest in the business. So, someone adding considerable value will not see that value reflected in their wallet.

It is also worth noting that you can combine an EOT with an EMI option scheme; options may be granted and, once they are exercised, shares could be sold to the EOT as a further management incentive tool.

As a firm we have worked with a number of entrepreneurs looking to exit their business in this way. It is a relatively new area and therefore working with people who understand the process is vital. There is a remarkable lack of awareness around the need for the trust documentation and tax structuring to be complaint with the legislation and it is important to ensure that the trustees fully understand their role and responsibilities.

It is always worth spending time with people to consider if this is the most appropriate route; we can help them to establish that and if it isn’t the best option for them, to point them in another direction. The EOT route is not appropriate for everyone but is certainly one that should be looked at when advising owners as to their exit strategies.