Employee Ownership Trusts: What is the true cost of good intentions?

According to the European Federation of Employed Shareholders, as of July 2024, 1,756 UK companies have been transferred to 124,000 employees via Employee Ownership Trusts (EOTs) since the scheme's launch in 2014. While this is an impressive statistic, can this approach be the optimal solution for all involved?

The benefits seem obvious: substantial tax advantages for vendors (less so for employees), the prospect of enhanced employee engagement and motivation, and potentially a smoother path to succession management. However, frequent stories of vendor regret are emerging. So, what can go wrong? Quite a lot, it seems!

As with all corporate transactions, the ultimate success of the transition depends on an alignment of interests among all stakeholders. Is the owner genuinely using the structure to promote long-term employee engagement, or is it simply a mechanism to save on taxes? Has the valuation been fairly determined, or has the business been burdened with a constraining funding structure that may ultimately prove too onerous? Has the transition of commercial decision-making been well thought through, managed, and made ultimately workable?

Frequently, the shift to a decentralised ownership model leads to underperformance. We're hearing increasing numbers of stories where, as a result, vendors never actually receive the bulk of their deferred payments, which are a common prerequisite in these transactions. Vendors often try to mitigate this risk by remaining in the background, still trying to steer the ship, leading to confusion about who is actually in charge. In some cases, much like in the AIM market, a proportion of businesses become stagnant due to shareholder inertia, reduced free cash flow, and limited access to future investment.

Acknowledging some of these pitfalls, the recent budget has imposed tighter restrictions around areas such as establishing true market value, ensuring control moves away from the vendor’s influence, and extending the period for potential unwinding of tax benefits from one year to four years if a disqualifying event occurs.

At Sovereign, we believe that for the right business and the right reasons, this structure can remain attractive. However, in businesses with strong growth potential, the private equity skill set can deliver far more value for vendors—through enhanced business support, tax-efficient multi-event value creation, and solutions to issues such as staff incentivisation, management succession, and alignment of stakeholder goals.

What’s key for any vendor is that they fully understand the range of solutions available so they can make the best decision. Feel free to contact us if you're a vendor wishing to explore your value realisation options.