How Is An Employee Ownership Trust (EOT) Funded

Looking for funding for your Employee Ownership Trust? Whether you’re looking to buy an EOT or sell your existing business to your employees, we can help you with the finance you need. While the finance market has traditionally been a challenge for EOTs, popular companies like John Lewis and Go Ape have recently adopted the model, forcing lenders that were once hesitant to reconsider the concept. 

Despite a rapid rise from 220 to 700 EOT businesses between 2018 and 2021, finding lenders who support EOTs can still be difficult, so it pays to have a team acting on your side. Rangewell’s team acts as your finance expert and helps you enjoy hassle-free finance that works for your business and your goals, as well as supporting the new company structure you’re aiming to adopt. 

What is an EOT?

An employee ownership trust is a company that is owned by its employees through shares. Began in 2014, the EOT model was pioneered by John Lewis and has since been adopted by many businesses in the UK. In fact, 1 in 20 UK private company sales are EOTs. 

The UK government defines an EOT as a business whereby all employees have a significant stake in the business. This requires two things: a financial stake and a chance to have input into how the business is operated. 

To have a financial stake, the business needs to be able to sell shares, making it easier for limited companies to become EOTs. Charities and sole traders will need to change their legal structure to be able to become EOTs or you’ll be unable to sell shares. 

EOT’s were originally introduced in 2012 and the goal was to increase productivity and inclusivity, with the expectation being that employees would feel more invested and therefore increase performance. Following their introduction, tax rules were established in The Finance Act 2014 to encourage businesses to become EOTs.

How does an employee ownership trust work?

An EOT essentially owns the controlling stake in the business, but to do so it must follow a strict process. In the UK, this process is commonly:

1. The EOT must be set up by the current owner by way of a trust deed.
2. The EOT is funded by capital contributions from the company. 
3. The EOT then purchases a controlling stake from the current owner. It must acquire more than 50% of the shares with any surplus cash to be gifted back to the EOT on completion. 

To become an EOT, the exiting owner must transition ownership to the employees, who will become co-owners. Employees will indirectly own the business and they will receive financial benefits normally reserved for shareholders. Exiting owners can either remain in the business with up to 49% of share capital or leave entirely. 

There are a few areas where EOTs are most commonly used:

1. Professional services: Most service-based businesses can benefit from moving to an EOT model as you’ll be able to better plan succession and ensure the passion and skills you’ve established can continue in your business once you leave. 
2. Public sector: Limited companies and social enterprises are often born from NHS and local government activities. In these public sector adjacent cases, EOTs ensure fairness and objectivity when running the business but also allows for more competitiveness and commercial focus. 
3. Start-ups: while you may not think of a start-up as an employee ownership concept, there are some useful applications for EOTs in this industry. If you’re a founder that wants to reduce your own exposure to risk whilst also building a sense of shared responsibility in your team. You’ll have to be an established start-up because we’d estimate that you’ll need around 10 employees for an EOT to work. 

Ultimately, selling your business as an EOT gives you more control over your succession. Where a standard business sale is usually done fairly quickly, an EOT exit is a longer-term approach that helps you protect much of your company’s culture, data, client base and employees. 

Selling your business to an EOT

Selling your business into an EOT is a popular option because it allows an entrepreneur to exit their business in a tax and cost-efficient way. By selling your shares to employees through a trust company, you’ll likely attract full market value and will not have to pay income, capital gains or inheritance tax liabilities on the disposal of the business.

Preparing your business for sale to an EOT can take years, as you’ll not only need to organise the right company structure and brief employees, but you’ll also need to devise how you want to be compensated. 

To facilitate the sale, owners must ensure employees can afford to buy the shares. The majority of EOTs are sold through deferred consideration, so that shares are paid back over a longer timeframe. Some owners may not like this option because it means waiting for future profits to be repaid for the sale. 

Alternatively, employees can raise capital through lenders, who will issue finance to the business as a business loan which is then repaid with future profits. A lender will therefore only lend to an EOT if there’s evidence of future profitability, making your business planning vital to your application’s success. 

If you need a finance lender, they’ll work with the employee trust or operating company, or sometimes both. They will assess the suggested structure of the EOT to ensure it fulfils the right requirements: 

• The EOT itself must acquire the controlling shareholding in the business
• The company seeking finance must be a trading company or a holding company within a trading group. 
• The EOT must offer the same terms to all benefiting employees
• The proportion of directors and/or shareholders with over 5% of shares must not exceed 40% of the business. 

Provided you can either agree to a sale privately with employees or you use a lender, you can then progress to selling your business as an EOT. The process takes a long time – waiting for HMRC to recognise the shift, and for your employees to undergo the correct mindset changes and develop the correct competencies. 

What are the benefits of an EOT?

In an EOT model, there is still a management team that oversees the day-to-day operations of the business. Employees still have a say in how the company is run and may even form a council, but a central management team is still in charge of the business as a whole.

When considering if an EOT is good for employees, it's also important to mention that employees can be paid an annual tax-free cash bonus of up to £3600 per person with no caveats because the company doesn’t have to be in profit. 

Aside from the bonuses, what are the pros and cons of an EOT on a wider scale? Here are a few of the benefits and considerations. 

1. Profit sharing: an EOT business is uniquely positioned to deliver cash to its employees through shares. The EOT pays out from its profits to owners and employees based on share percentages, as well as tax bonuses. 
2. Improved business performance through greater engagement: less absenteeism, higher productivity, fewer internal complaints or challenges. 
3. Tax savings: you won’t have to pay income tax, capital gains or inheritance taxes on any shares sold to an EOT. 
4. Sales opportunities: if your business operates in a niche sector, your market is limited. An EOT gives you a new way to sell your business without having to navigate a sales market. 
5. Culture: selling to an EOT means you’ve got some reassurance around how the company will be operated once you leave as the employees involved will hopefully respect any established culture. 
6. Flexibility: you don’t have to exit a business fully to become an EOT. You can sell 51% to an EOT and retain a 49% share, allowing you to make choices about your future role in the business. 

Funding an EOT

Like any business, EOTs need capital to grow. Trustees also need to raise capital to purchase shares in the business. For those reasons, funding an employee ownership trust becomes a question of securing external finance that can be used to funnel growth.

Traditional lenders hesitate to work with EOTs because they present a riskier option than a standard business structure. Any funds granted will be repaid in the future on profits, which means a lender is highly exposed, and any drop in profitability will impact them directly.

How to fund an EOT

Alternative lenders now exist to help plug the gap left by hesitant banks. These lenders can offer business loans of around 3-4 times your EBITDA provided you can prove the strength of the business and illustrate potential risks and growth plans over the next few years. 

For any business considering becoming an EOT or an existing EOT looking to raise capital, the message is clear: the more effort you put into planning your financial projections and making an application as strong as possible, the less risk you’re deemed to be, and the more likely a lender is to offer you funds.

This is always the case when seeking a cash flow loan because the lender needs to take a long-term view of your profitability and determine if the investment will be worth it. 

EOT finance issues: why lenders won’t finance an EOT directly

An EOT cannot offer security or guarantees around money it is not borrowing, so if it tries to borrow money as a company, a lender has no security over shares. To mitigate this, the majority of EOT finance agreements are vendor finance through a trustee. Additionally, the EOT itself may not actually generate the money needed to repay a lender – instead relying on the owning company to transfer funds into the EOT then back out to the lender, which obviously poses risks for them. 

However, all of these issues can be resolved with a well-drafted agreement and by working with a lender who understands EOT structure. Rangewell can help you make the right decisions around funding an employee ownership trust, aiding you through processes that include:

• Finance For Selling an EOT: as the seller, you can either encourage employees to take on outside debt, which requires the support of a specialist lender, or create a subordinate debt agreement where the employees pay you back from the future profits of the business. This agreement must be drafted by a legal professional with full oversight from an accountant to ensure it works for both parties. 
  • Only you can make this decision based on how quickly you want to be compensated and how much you can guarantee your business’ future will be profitable once you leave. If you want further advice, we can help provide impartial insight into external lenders and how they can help you sell. 
• Finance For Buying an EOT: if you’re an employee and want to buy into your EOT, you’ll need to either raise finance from a lender or be part of a subordinate debt agreement. You’ll need a team of employee representatives who can apply for finance as a trust, which mitigates any personal circumstances but requires a lender who understands the sector. 
• EOT Finance For Growth: as with most forms of borrowing, an EOT’s first duty is to repay the vendor. However, as you aim to grow you’ll also need other forms of finance such as a general business loan. Lenders are often hesitant to offer this form of finance to EOTs due to the reasons we’ve outlined above. Work with Rangewell and we’ll help you mitigate any issues and secure finance that helps you grow. 

 

Asset finance for existing EOTs

In some circumstances, you could also explore asset finance. This is a form of finance that sees a lender issue funds based on the value of an asset you want to buy. This asset is part of the security, allowing the lender to reduce their risk as failure to repay the loan would see the asset seized. 

In cases where you have an existing EOT that needs funding for certain equipment or machinery in the business, asset finance may be a more accessible form of finance than a cashflow loan. It is not relevant to buying/selling the EOT itself, but is a useful option for businesses that need to finance important purchases. 

Find employee ownership trust solicitors and accountants

Due to our extensive experience in the sector, we have built relationships with lenders and a network of skilled legal and financial professionals that can help you optimise your EOT sale or purchase. When working with Rangewell, we will suggest expert employee ownership trust solicitors, accountants and other professionals - which saves you the research time and ensures you choose only those providers who have demonstrable experience in the EOT finance process.. 

Finance your EOT with Rangewell

Whether you’re an owner looking to sell, a trustee seeking to buy or an existing employee in an EOT that needs finance for growth, we can help you. Our team are experts in financing all manner of businesses and understand the lender’s market inside and out. 

Not only will we talk you through the available lenders and the types of finance you can access, we’ll also help you understand the entire process behind EOT financing and guide you to the best outcome. Get in touch today to see how we can help you.