Employee ownership trusts (EOTs) are on the rise as a business management model, increasing in number in the UK by an average of 23% a year – with a recent peak of 30% in 2023. But what exactly do they entail, and what are the long-term implications for vendors and employees? Firebird co-founder Stewart Lambert unpacks some of the key issues from the corporate finance perspective.
It’s the topic that almost everyone wants to ask us at Firebird right now: are employee ownership trusts (EOTs) worth doing? The answer to that is complex and, for some, will depend on information that’s neither available in the sector yet, nor being widely discussed – at least not in the majority of articles I’ve read about EOTs to this point.
“The concept of EOTs is positive”
EOTs are an interesting and fairly new phenomenon, which first gained royal assent in 2014. They were designed to give founders and owners very generous tax reliefs for passing on majority shares to their employees, in a move that sought to create a new wave of John Lewis-style set-ups: employee-owned businesses (EOBs) that give each employee a tangible stake in the company. The aim is to motivate commitment from everyone to help the company succeed for years – even decades – to come, thus creating a tide of sustainable and empowering future-focused British businesses.
The concept then is positive, much like the majority of coverage about EOTs that’s out there. And I see instances in travel where EOT set-ups are clearly achieving what the model was created for – i.e. inspiring teams for the long-term, and continuing the generous philosophy and mindset of owners who opted to select them, rather than, say, a management buyout (MBO) or other more traditional types of exit.
But are all EOT arrangements in the UK today being used for the purpose the legislation was designed for? And are the possible downsides sufficiently known to teams and vendors? I believe these are really important questions for leaders in sectors like travel to consider.
“Vendors can sell their business free of capital gains tax while retaining up to a 49% share”
The received wisdom is that EOTs are brilliant for the vendors, who can sell their business free of capital gains tax (CGT), while also retaining up to a 49% share of the company. Ask the online hive mind that is ChatGPT for the pros and you’ll also get a list of arguments that EOTs create:
A more inclusive ownership model, “where every employee can potentially benefit from the business’s success, leading to a more motivated and engaged workforce”.
Continuity, since “employees are more likely to maintain the company’s mission when they are also owners”.
Greater productivity, given that “when employees feel like true owners, they may take greater pride in their work and contribute more toward the company’s success”.
But would this be the case for every business?
What if you’re an aspirational manager who has thoughts of one day owning your own company? Or an employee whose team has ambitions to accelerate growth and reap the rewards?
And what if your EOT experiences financial trouble, as businesses sometimes do?
“It’s important to consider what could happen after the EOT is established”
Some financial advisors out there seem to be marketing EOTs purely as tax-free exits for the vendor; packaging up the arrangement as a CGT-free exit planning strategy – without much emphasis on, or thought for, the management team taking over.
If the acquiring team has dreams of making large profits and boosting the value of their shares, they may find there are significant obstacles in their way further down the line in terms of benefitting from that growth. Note that the value of the business/shares will accrue to the trust rather than to individual employees. That means there are very strict limits on what tax-free bonuses workers can get, or how much capital value they can realise.
This may not be a problem for some teams. After all, there are millions of people in the UK who contentedly work for owner-managed businesses. They go to work, they’re paid a salary, they’re happy. Those people may perceive EOTs as a gift: they’re being given something they didn’t have previously, and the chance to become part of the management structure in a way they may never have previously anticipated.
To be clear, I am looking at this topic through my own particular lens of capital creation and realisation for clients. So it’s worth saying that, when I’ve asked around as to how people actually make value from EOTs, one response I received is that I’m looking at this from the wrong perspective. That nobody needs to personally benefit in a significant way financially in the future: the aim is that the business remains under employee ownership, and that’s what the legislation is designed for.
And a number of EOTs are clearly being structured for the right reasons – i.e. to sustain the business’s future, and the future of its employees. However, for those instances, it’s also important to consider what could potentially happen after the EOT is established, in the short, medium, and long term. That piece needs careful consideration from teams and vendors alike.
“The ramifications of vendors retaining a share could be complex”
So for vendors: let’s dig deeper into the personal financial benefits open to them through EOTs, assuming this is what they’re primarily after. (Note: as above, there are some owners and founders for whom money will not be the top priority.) Yes, there is a CGT-free payout. But realising this can be complicated.
In an MBO, a vendor can potentially get all their money off the table on Day One. But under an EOT structure, that’s not possible: they may have to wait five years (or longer). Meanwhile, by retaining a stake in the business, they’re not really able to disengage from how it operates – so they still have the pressures and burdens of ownership – and the risks.
During that time, if the value of the business goes down, if trade falters, if an unforeseen and impactful event comes to pass – e.g. another pandemic – the vendor may not be able to realise the cash they expected, and may then even need to become involved with the business’s running again.
Yet, since the EOT owns at least 51% of the shares, legally the previous owner should not be running nor controlling the business (a point which seems to be completely lost in any debate around EOTs). The possible ramifications could be complex.
The other key consideration is: what could the fallout be for employee-owners in these situations? What happens if the team becomes demotivated? Would they be able to sell and reap the benefits of their work sustaining the company? The restrictions embedded in EOT models look likely to make that extremely challenging.
I’d recommend taking a look at this recent piece on EOTs from HMT LLP (a firm with whom Firebird has worked regularly over the year) which describes more of the nuances and possible drawbacks in detail. These details are something I’d like to see worked through and discussed more in EOT coverage rather than the very narrow focus on the tax-free disposal.
“There is still a degree of uncertainty”
In the meantime, let’s go back to ChatGPT. When putting this article together, I consulted the platform for a calculated opinion on what may be to come for some EOTs out there in the decades ahead. “While Employee Ownership Trusts (EOTs) have been gaining traction,” it replied, “there is still a degree of uncertainty about the long-term consequences.” It added: “long-term data is still relatively limited”.
After listing the reported positives, ChatGPT then offered the heading “What is still unclear”, breaking its answers down into four sections:
Long-term business sustainability: “while some companies seem to thrive under employee ownership, others may face challenges that could threaten their longevity”.
Impact on company culture over time: “while employee ownership may create a strong sense of collective responsibility initially, it’s uncertain how that dynamic will evolve over time, especially as new employees join and company leadership changes”.
Effectiveness of long-term exit strategies: “The long-term effectiveness of this exit model is still uncertain, especially in terms of liquidity for employees who may need to access their funds.”
Economic resilience and adaptability: “another area that requires further investigation”.
The platform concluded that “any downsides or challenges may only become fully apparent… once companies have gone through multiple cycles of ownership, employee turnover, and economic shifts”. That is also my view, and I will be following what happens closely.
Stewart Lambert is co-founder of the Firebird Partnership, with over 25 years’ experience in corporate finance, advising owner managers on selling their businesses, raising finance and making acquisitions.
Learn all about Firebird at www.firebirdpartnership.com
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