By Palma Percze, Solicitor in the Corporate Team at Myerson Solicitors

Employee Ownership Trusts (EOTs) are an increasingly attractive route for business owners seeking a meaningful exit as they offer a strategic succession solution, combining long-term business sustainability with significant benefits for both owners and employees. The disposal of shares to an EOT can be exempt from capital gains tax, and employees may receive income tax-free bonuses of up to £3,600 annually.

This article explores how equity and debt financing can be used to finance EOT transactions.

What is EOT Funding?

EOT funding refers to the mechanism by which the EOT finances the purchase of shares from the existing shareholders, noting that as a newly formed trust, the EOT will not typically have existing assets or cash reserves and must therefore secure capital to fund the acquisition.

Equity-Based Funding

In most EOT transactions, the purchase price is financed through a combination of the company’s existing cash and deferred consideration. The latter involves paying the outgoing shareholders over a number of years using the company’s future profits.

This deferred model relies on the business’s continued financial health. As such, it is essential that careful consideration is given to projected cash flow, and that flexible repayment terms are negotiated within the share purchase agreement. This ensures that payments to former shareholders can be maintained without undermining the company’s liquidity or operational stability.

Debt-Based Funding

In cases where equity finance is insufficient or unsuitable, perhaps as part of a strategic exit plan or the age of the vendors, debt finance may provide an alternative option. This involves the EOT (or more likely, the company on its behalf) borrowing funds from a third-party lender to fund the initial payment.

Debt financing may also be appropriate for businesses looking to refinance an EOT transaction which was previously equity funded. For instance, an EOT might later opt to replace deferred payments with a loan to accelerate settlement to the selling shareholders or to release capital for reinvestment.

When securing external funding for an EOT transaction, it is crucial to review the provisions of the loan carefully, particularly any terms that might grant the lender control over the company in the event of a default. Should an event of default occur, this could jeopardise the EOT’s qualifying status and lead to the loss of valuable tax reliefs.

While some traditional lenders may still be cautious about the EOT structure, specialist finance providers do exist and can offer tailored lending solutions aligned with the unique characteristics of EOT transactions.

Choosing the Right Funding Strategy

Transitioning to an EOT is not merely a legal process, it is a strategic change in business ownership that can safeguard legacy, promote employee engagement, and foster long-term growth. The funding structure adopted plays a critical role in ensuring that the transition is financially sound and sustainable. Accordingly, the appropriate type of funding will depend on the specific characteristics of the business, the preferences of the selling shareholders and the long-term strategy for employee ownership.