Employee Owned Trusts (EOT’s) are becoming an increasingly popular way for businesses owners to realise the value in their business when they exit. A number of well known businesses have gone this route, like Ardman Animations, Go Ape, and Richer Sounds.
According to the Employee Ownership Association there are now 1,418 employee owned businesses in the UK, yet they can be unpopular with credit insurers and bond underwriters (sureties). It’s worthwhile having a look at why.
How does it work?
The original owners of the business sell it to a specially set up employee owned trust, owned by the employees (clue is in the name). Since 2014 there can be significant tax benefits in this route for the exiting owners, and there can be financial benefits for the employees as well. It’s also seen as a great way of motivating the employees, who all become shareholders, and there is some evidence (from the EOS) that employee owned businesses simply perform better, with higher profits, better staff retention, and improved employee engagement.
Sounds good. Why don’t credit insurers like them?
There are 2 issues, firstly the valuation itself is largely in the hands of the exiting shareholders, and secondly how the sale works. In simple terms, the initial payment to the exiting owners is made out of the cash in the business, with the remainder deferred over a period of time. How the deferred element works is key, and this is often in the trust/sale document, not something in the public domain, and therefore something insurers can’t see. Some are based on a percentage of profit, some on a percentage of turnover, and many are much more elastic than that. More to the point, some have failed, and in quite spectacular fashion – Buckingham Group being one of the more recent. Where a business is already operating on slim margins, an inflexible EOT agreement can leave the business short of cash, and therefore liquidity, and it doesn’t take much going wrong to put them in the hands of the receiver.
So to be avoided then?
Not at all. The concerns that insurers have expressed has been largely in the construction sector, and to be fair to EOT’s they have been hit by the same issues as all other businesses – rising interest rates, supply chain inflation and increased energy prices. It is a moot point as to whether an EOT is any more vulnerable than other businesses. Richer Sounds is a very well known success story, and John Lewis, whilst not exactly an EOT, have been employee owned since 1929. So caution, but not to be dismissed.