Selling a business via an Employee Ownership Trust (EOT) is becoming an increasingly popular choice for business owners who are looking to begin their transition out of their business and to hand over its succession to the next generation of management. Yet, despite their increasing popularity there is relatively limited conversation had in available guidance about Trustee responsibilities once the EOT is set up and running. From my perspective both as an experienced advisor to owner managers selling to an EOT and, more recently as a Professional Trustee on the Board of Trustees for some of my clients, I set out below what Trustees can expect in that initial period following the creation of your EOT.
What is an EOT?
An EOT is a tax incentivised mechanism that transfers control of the business for the long-term benefit of employees. It is, in essence, a vehicle for a planned exit – it is not considered a quick sale, and it isn’t for owners who want to step out of the business in the foreseeable future or take a considerable amount of cash off the table immediately following sale. Instead, it is a way to ensure that the right succession is in place, and that it is done in the best interests of the business and its employees going forward.
For more detail on what an EOT is, eligibility criteria, tax benefits and the process, you can read our article here.
The Board of Trustees
Once an EOT is set up, most of the responsibilities of ensuring the success of the Trust fall to the Trustees. Similar to other types of Trusts such as Charities, Family Trusts, and Will Trusts, EOTs are governed by Trust Law which provides that each Trustee must be responsible for the assets and activities of the trust, on behalf of its beneficiaries. Only, in the case of EOTs the beneficiaries are the employees.
The Board of Trustees is typically made up of, as a minimum, an Employee Trustee, a Professional/ Corporate Trustee, and often one of the sellers will take a Trustee position too. The Board is not restricted to one Trustee per representative group.
- The Employee Trustee is appointed to represent the interests and perspectives of the employees. In larger companies, an Employee Council (or multiple, if the company structure warrants it e.g., in the case of businesses that span multiple sites or with distinctive operational departments) may be set up and they will appoint a representative from the Council to sit in the position of Trustee. However, Employee Councils are not a requirement and is at the discretion of the business and its employees to decide. In lieu of a Council, and more commonly in smaller businesses (<50 employees on single sites) an Employee Trustee is typically appointed from among the managers of the company.
- The selling shareholders typically appoint a Trustee in order to smooth the transition of ownership; most EOT transactions do not include all 100% of the shares of a business being sold to an EOT on day one, at the very least because typically an EOT is funded in part by vendor loan, so they continue to have a vested interest in the business and it is a fantastic opportunity for the new employee owners to be able to learn from someone who has longstanding experience in running and growing the business.
- The Professional Trustee then sits in the middle as the lynch pin. They are required to provide a truly independent view and maintain a balance of perspectives to ensure that neither the selling shareholder nor employee perspective is over represented. In this position, a business needs someone who is going to act in a way that is free of conflict; someone who can stay aligned to all parties and none, while ultimately recognising that employee are the people that the EOT is there to serve.
The immediate priorities are not prescribed by any regulatory or legislative requirements – they are primarily cultural. The main priority is to ensure the employees understand the extent to which they now have involved in the Trust and, by extension, the business. This challenge has a couple of aspects:
- One of the unusual aspects of an EOT is that no individual employee has a share certificate with their name on. The EOT is owned by the body of employees at any one point in time. Understanding this is important for two reasons:
1) Employees will need to understand that they do not personally own a percentage of the business (unless they have been allocated shares or options separately to those held in Trust), and
2) It is vital that employees understand that they are working for each other’s benefit whilst they are in the business, and not just for their personal benefit.
Often this second point is very quickly and easily grasped and is one of the biggest benefits of an EOT to both the business’ culture and overall performance.
- On occasion, when an EOT is set up some employees enter a mind-set of ‘we can do what we like now’ and don’t really comprehend that the EOT is about long-term transition of ownership. Whilst from day one 51% of the company’s shares are owned in Trust, only a small proportion of the purchase price has typically been paid in those initial stages. Therefore, it’s going to be down to the future success and profits of the company that will enable long-term value to be transferred from the seller to the employees in the EOT, typically taking 3-5- years and sometimes longer.
This second aspect brings about another important priority of the initial stages of EOT establishment. In a significant number of the cases that we’ve seen, the new employee owners are coming from operational or focussed ‘employment’ roles. For many, particularly those sitting as Employee Trustees or members of an Employee Council, this is the first time they will have been in a position to consider the strategy and direction for the business. Therefore, it is important to ensure they have sufficient support in understanding the additional responsibilities and skills required, and how their role will play into the success of both the Trust and the business.
Many of these additional responsibilities will involve the understanding of and decision making regarding financial and strategic aspects of the business. Often the experience of sitting alongside the selling Shareholders on the Trustee board can provide invaluable experience that they can learn from. It can be helpful to consider sending Employee Trustees with management aspirations on suitable training courses to improve their managerial capabilities and financial understanding. This challenge is also particularly relevant if the establishment of the EOT coincided with a partial Management Buyout (MBO) or purchase of shares by managers. In those circumstances, there are additional things to consider in ensuring the new management team are prepared for the undertaking of running the business.
For the business itself, once the original EOT transaction is done, there is an opportunity to be able to return to focussing on commercial and operational matters. Ultimately, the successful performance of the business will secure the success of the Trust, so getting “back to business” is the best thing the business can do.
Once the Trust is established, the main requirements of the EOT Board is to assist with developing and ultimately provide a decision on whether they support the annual business plan or not, as presented to them by the Board of the company. It is expected that the Trust will have, at least, an annual general meeting (AGM) to review the accounts and plans for the coming year.
Beyond that, the Trustee Board should only be presented with items for approval on an exception basis or at the decision of the specific Trust. For example, if the business is performing in accordance with the plan set out then there is no need for the Trustees to be further involved (provided repayments to the vendor can be met), as to do so might undermine the management team of the business itself. However, if things are not going to plan or there are growth opportunities available to the business that fall outside of the previously agreed business plan e.g., acquisitions for growth, appointing major employees on high remuneration packages, or major organisational restructures, then the management team/Board of Directors should be consulting with the Board of Trustees on these matters. The general running of the business and any additional expenditure to achieve growth objectives (up to a certain point*) remains within the remit of the management team/Board of Directors.
*While company spending is broadly at the discretion of the Board of Directors, certain levels of spending need to be reviewed by the Trust, both for good governance and to ensure that it does not impact the Trust’s ability to meet repayments to the vendor by restricting the available cash and profits necessary to fund contributions to the Trust for the vendor loan repayments.
Generally speaking, once an EOT is established, the ongoing management of the Trust should be relatively straight forward. Nevertheless, it goes without saying that there is a huge amount of pragmatism required from all parties of the Trust. For employees to have something that is of beneficial value to them, all parties must recognise that it will take time as the EOT is only funded by the success of the business and the Trust’s role is look after the investment of interest in the business, not run the business itself.
The exact priorities, challenges and responsibilities for the Board of Trustees will vary from business to business, depending on the nature, size and structure of the business, and the structure of the Trust.
If you would like further guidance for your particular circumstances, or would like to talk to us about EOTs, please contact Simon Blake, a Corporate Finance Partner at Price Bailey LLP, using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.