The John Lewis effect: Is an Employee Ownership Trust right for your start-up?

Jenny Burke of Forbes Solicitors explains the pros and cons of an EOT ownership structure
Jenny Burke
John Lewis

Despite controversial recent news that the John Lewis retail group, which is 100% owned by its staff, is considering diluting its partnership structure, Employee Ownership Trusts (EOTs) are continuing to grow in popularity.

The model was introduced in 2014 by the Conservative-Liberal Democrat government and since then, the number of businesses selling a majority stake to an EOT has rocketed – HMRC received over 430 applications for EOTs in 2022, up from just 19 five years ago. We have continued to see an uplift in business owners considering this option over the same period.

But how do employee-ownership models work and what are the benefits? Here, corporate partner Jenny Burke from Forbes Solicitors explores what’s driven such a surge in popularity and how you could benefit from putting the power into the hands of your workforce.

What is an EOT?

An EOT is a business model that enables an organisation to become owned by its employees. Not through direct share ownership but via a controlling interest in the company, which is transferred to an all-employee trust and held for the benefit of staff.

Trusts are set up by a business’ owners – either as part of their exit or succession planning strategy, or by founders who want to start a new venture with a committed and engaged workforce and strong shared purpose.

What are the benefits?

In becoming employee-owned, a company indicates a firm commitment to the wants and needs of its workers – and this can transform internal culture.

A shift in ownership and control from the traditional ‘top-down’ structure often leads to increased employee engagement and loyalty, a drop in absenteeism and boosted retention. Naturally, when an employee recognises that they can benefit directly from the business’ success, there’s an invigorated sense of innovation and improved business performance.

EOTs also offer attractive tax benefits for all parties. For business owners, shares transferred into the trust can be made free from capital gains tax and inheritance tax, while employees can be paid income tax free annual bonuses of up to £3,600 and corporation tax is deducted for the value of bonuses paid.

How can you set up an EOT?

An EOT is setup through a trust deed which is put in place by a solicitor. The trust is then run by carefully appointed trustees whose role is it to ensure the company is well-managed and run in a way that maximises employee engagement. The model relies on trustees to behave with good conduct and make decisions in the best interest of the workers they represent, holding the company’s board to account when needed. This is sometimes facilitated by the creation of an Employee Council – a representative body elected by employees to appoint and remove the EOT’s trustees.

The trustees and Employee Council are required to agree a share price with the selling shareholders and an expert Share Valuation will be carried out. Once agreed, the Share Valuation will form part of the Share Purchase Agreement (SPA). It’s key to appoint the right advisers as soon as you start this process so that they are able to help with scenario planning and what’s right for your business.

How is the share purchase funded?

There are several different ways to fund an EOT and the best option will be dependent on various factors such as forecasted future profits, valuation, available cash and credit status.

The most common funding approaches are:

  • An external loan to the company – in this scenario, the bank loan will be repaid with interest, out of the business’ future profits. It’s usually still necessary for existing profits to be used to pay the rest of the purchase price to the selling shareholders, as it is unlikely to be possible for a bank to lend the full amount
  • An external loan to the EOT – a loan can sometimes be made directly to the EOT rather than through the company. This is preferable and less complex but depends on the company having a strong financial position
  • Using surplus cash – when a business owner sells their company to an EOT, they will be paid in instalments over time from future profits. However, if the business has any surplus cash on the date of sale, it can be possible to use this to fund a down payment. Each payment will be funded by the company making a payment to the EOT, which the EOT then uses to pay a purchase price instalment.

If you’re a founder exploring different ways to engage your people, giving them a stake in the success of the organisation can be a powerful catalyst for improved performance – putting an end to employees wondering ‘what’s in it for me?’ and encouraging a culture of collaboration and productivity.

Written by
Jenny Burke
Written by
May 4, 2023