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The future of EOTs

EOTs: The Holy Grail for Business Owners - or Simply Passing the Buck?

Back in May, HMRC unveiled the findings of a qualitative evaluation of Employee Ownership Trusts (EOTs) produced by Ipsos. While the conclusions were largely unsurprising, they hint at a continued evolution in the M&A landscape that could see EOTs gain even greater prominence.

A brief history of EOTs

EOTs, in their current form, have been a solution to business owners evaluating exit options since 2014, following the Nuttall Review into Employee ownership.

Uptake was initially modest, with the number of EOTs established annually sitting in the double digits until 2019.¹

However, in the past 5 years, EOTs have grown exponentially in popularity, with current estimates suggesting there are now approximately 2,250 in existence.²

In fact, renowned employee ownership expert Graeme Nuttall, who undertook the 2014 review, stated in 2022 that EOTs were already a mainstream business model.³ This is echoed across the corporate finance community, as any advisor worth their reputation now raises EOTs as a viable option for business owners considering succession.

Alternative Exit Strategies

Beyond EOTs, traditional options such as a sale to a trade buyer or management buyouts/buyins (MBOs/MBIs), whether private equity backed, or debt funded, continue to dominate exit options.
For vendors prioritising maximising consideration, trade buyers have historically been the most likely source. Larger trade buyers, particularly listed companies, are often valued at higher EBITDA multiples due to their reduced risk profiles. This allows them to benefit from natural arbitrage: acquiring at 5 x EBITDA and adding to their own capitalisation at, say, 10x EBITDA – where perhaps other buyers could not stretch that far.

Will the Most Recent Tax Changes Drive Even Greater EOT Uptake?

Following the Chancellor’s 2024 Autumn Statement, which included increases to both Capital Gains Tax (CGT) and Business Asset Disposal Relief (BADR), EOTs may now offer vendors the highest net consideration – even if headline multiples are lower.

At present, in selling to an EOT business owners could avoid paying CGT at 14% on the first £1m of proceeds under BADR, climbing to 18% from April 2026, and 24% on anything above that. Banks are also increasingly comfortable lending to EOTs, limiting the extent to which proceeds may need to be deferred.

A sale to an EOT can also be more straightforward in that there are no protracted negotiations with potential buyers, with the process typically involving only an independent valuation, legal counsel and potentially third-party debt as external parties. The Ipsos report concluded that participating sources generally found that the EOT transition is considered to be a smooth process.⁴

Long Term Prospects: EOT’s Beyond Initial Transition

While the benefits at the point of sale are clear, the long-term success of EOTs is yet to bore out. For those now approaching maturity with former owners looking to step away, attention will shift to how these businesses sustain growth and leadership.

With the value more widely distributed amongst the employees, traditional management incentives may weaken. Will senior staff still be motivated to take on leadership roles if they no longer benefit from a significant capital upside? The counterargument, of course, is that employee ownership may reduce the need for hierarchical leadership altogether, but what of strategy in a market downturn?
The Ipsos report correctly identified the level of engagement of employees as another key factor in the success or failure of transitioning to an EOT, but the same is undoubtedly true of the long-term prospects, particularly for senior staff.

A hybrid EOT model could help address this concern - only 50% and one share of the company must be held by the trust to qualify – providing room for EMI schemes or other management incentives. Given the low number of early adopters, few mature case studies exist to evaluate the success of such a model.

The profit generated by an EOT can also be allocated amongst staff in a variety of ways that are deemed fair. This can be as straightforward as everyone gets the same, number of hours worked, length of service, or - the method which might help incentivise senior staff the most - on a pro-rata basis in line with salary.

This is a bonus and so subject to income tax. For senior management who might have otherwise been drawing dividends after an MBO, not only will the gross amount likely be less, it will also be less tax efficient, but below management tier level, something is surely better than nothing?

The first £3,600 will also be exempt from income tax, although Ipsos concluded this was less of a primary motivation for setting up an EOT initially. Performance based bonuses can still be paid alongside EOT bonuses, but clear distinction must be made and EOT rules followed.

Selling from an EOT

An often-overlooked drawback of EOTs is the difficulty of exiting the structure once it’s in place. In short, the initial CGT is deferred at the outset – not waived – and in most instances becomes payable by the trust in the event of a sale.

The October 2024 CGT reforms extended the clawback period for which the previous owner must pay the original CGT from two to four years. While this will further protect the trust it also curiously gives rise to a potential conflict of interest: if the trust receives a lucrative offer within this window, accepting it may trigger a large CGT bill for the previous owner – who will likely still sit on the trust board.

Private Equity firms have equally found EOTs challenging to invest into due to these constraints. That said, there are exceptions: as covered in the ICAEW Corporate Financier magazine last year⁵, Agathos successfully structured a buyout of Plowman Craven, setting a precedent for how PE can invest into EOT models.

With limited exit options and the reduced equity slice available to incentivise management teams and/or private equity investment, the big challenge on the horizon for many EOTs of how to take the next step will be quickly coming into view. It may well be that some EOTs are locked in for the long term by the absence of any alternative strategy as opposed to it being a successful structure.

Advice for Business Owners

With the autumn budget now set for 26th November, more column inches will surely be dedicated to potential tax increases by the Chancellor to combat higher than expected government borrowing.

The conclusions of the Ipsos/HMRC evaluation would suggest that despite this pressure EOTs - and critically, their tax reliefs - are here to stay, but the true test of their ability to future-proof businesses is arguably just beginning.

Interestingly, the evaluation fell short of identifying the dominant driver behind EOT adoption, beyond acknowledging CGT relief as the most attractive tax feature, which is surely no surprise.

It did however conclude that changes to CGT relief would likely influence the decision to opt for an EOT model over other exit strategies and it is unclear whether we should extrapolate from this that the CGT exemption is therefore the biggest factor overall.

This may suggest EOTs are being adopted in some cases where they aren’t necessarily the most appropriate long-term structure, but to take advantage of the tax reliefs – a risk that advisors must remain vigilant to when guiding clients through succession planning.

If this (and the previous) governments’ objective is to increase employee ownership more broadly, then the tax relief is undoubtedly helping, but advisors’ priority must still be what’s best for the individual client here and now.

Ultimately, when evaluating an exit, business owners and particularly founders may still find themselves in the predicament of weighing up what’s best for them versus what’s in the best interest of the business and its employees.

Undoubtedly, there will continue to be many scenarios where EOTs offer both the most financially rewarding and culturally aligned exit, so if you are a business owner wishing to discuss your exit strategies now or in the future, please do get in touch.

*EBITDA – Earnings Before Interest, Tax, Depreciation and Amortisation is the most commonly used profit figure for deriving business valuations, as it is often considered the closest approximation to operating cash before finance costs and capex.