Employee Ownership Trust or Management Buyout?

As a successful business owner/manager, it is likely that you will have at some stage contemplated an exit strategy. Perhaps your exit plans have become accelerated by unexpected factors, for example, relating to either your personal circumstances, or the performance of your business, or the impact of wider economic and tax issues. Or it’s possible that you are reaching the culmination of a long-planned exit strategy. While the traditional route of a trade sale to another corporate or a private equity-backed buyer might seem like the only option, there are alternative exit routes that could better align with your personal and business priorities. Two notable options are an Employee Ownership Trust (EOT) or Management Buyout (MBO).

Why choose an employee ownership trust or management buyout

There are likely to be a large number of issues that may be relevant to your analysis. If most or all of the below points are important to you, then either a sale to an EOT or a friendly MBO might be worth considering. These exit routes will not be applicable in all circumstances, and there may be compromises compared to trade sales.

1. How important to you is your personal legacy and the legacy of the business?
2. Are you intending to facilitate a seamless transfer of ownership, and minimise the potential disruption of a change of control and culture?
3. Would you like to reward your management team and employees, and give them an opportunity to continue the growth of the business for mutual benefit?
4. Do you think your management team will be able to operate effectively without the pressures (or discipline!) that may be imposed by a private equity investor; and do you trust that they have the skills, initiative and motivation to be able to continue to be responsible custodians of your business?
5. Are you concerned about putting the business under the potential stress of a leveraged buyout; or the uncertain consequences of a sale to a competitor?
6. Is it important for you and your business to ensure that the prospect of a potential change of ownership is kept confidential and to minimise the risk of leaks to your competitors, suppliers, customers and staff?
7. Do you want to avoid having to answer extensive due diligence enquiries, issued by potential purchasers who are still less likely than your management team to understand your business (and who may use their findings to justify a price chip)?
8. Do you want to have an accelerated transaction process, where you have certainty that the key deal terms will not be changed by an opportunistic bidder, and you may not be required to give substantive warranties and indemnities that could be used as a retrospective price adjustment?
9. Are you concerned about incurring substantial transaction costs, and the risks of those costs being wasted if a transaction fails to complete?
10. Do you want to be able to choose whether to have an ongoing role in the business, and whether to retain an ownership interest?
11. How important is it to minimise the tax payable on your sale proceeds?

Management Buyout

Under a Management Buyout, typically some or all of the existing management team (and possibly some new incoming management eg to provide additional necessary skill sets/experience) purchase the company from the exiting shareholder(s). The purchase can be backed by all or a combination of (a) funds invested by the management team, (b) bank debt, (c) institutional investors (PE/VC), (d) vendor debt (deferred consideration) and/or or (e) excess cash in the company.

There is no standard definition of a “friendly/soft” MBO. Typically they do not involve private equity investment, and they would normally involve a consideration structure with significant deferred payments. They may involve direct investment by the management team, and/or some debt funding eg secured on receivables or other assets of the company. They were historically more common on smaller deals or where the sellers were unable to (or chose not to) invite a trade sale, and the management team could not (or chose not to) obtain PE investment. However, their popularity has increased, especially where the sellers of an established owner managed business have confidence in their management team and accordingly are willing to accept a deferred payment structure.

Employee Ownership Trust

Employee Ownership Trusts were introduced in 2014 to encourage employee ownership. Despite some early adoption by some household names (Richer Sounds, Aardman Animations), it has taken some time for them to catch on. However, they are becoming increasingly popular as they become more familiar to advisers, funders and business owners. In 2017 there were only 11 new EOTs; by 2023 the number had increased to 542.

In an EOT arrangement, a trust purchases at least a majority of the shares in a company and holds the shares for the benefit of all the employees of the company.

In order to ensure that they are used for their intended purpose, EOTs are subject to a number of compliance obligations, some of which have been tightened in the October 2024 budget.

However, they do have some significant tax benefits. In particular, the selling shareholders may not have to pay any CGT; provided that the company is not sold within two years, the tax charge they would have paid is rolled over and becomes payable by the EOT if it sells the company down the line. Also, employees are entitled to receive an annual tax- free bonus from the company (currently capped at £3,600 per employee).

The biggest difference between a sale to an MBO team and a sale to an EOT (apart from the tax treatment of sale proceeds) is that an MBO can be led by (and the company or a proportion of it owned by) a small number of senior management team members: under an EOT, ALL employees are entitled to share in the benefits of company ownership on an equal footing.

In practical terms, the Employee Ownership Trust requires a separate board of trustees as well as a board of directors to run the trading company, and there is a level of complexity around the governance involved in keeping these two entities separate with slightly different duties and obligations.

Further considerations

There will inevitably be a large number of factors for business owners (and their management teams) to consider when assessing exit options. Not all exit routes will necessarily be viable for the parties involved and the business itself, and the number of (sometimes conflicting) factors can make it difficult to assess the optimal option.

For example, are the sellers willing to potentially accept a lower headline purchase price and extended deferred payment terms in return for a lower tax bill and/or greater assurance that the business will continue to operate under its existing management and employees?

And are the management team willing to operate within an EOT structure that involves indirect ownership by all employees, and where they may therefore have less direct ownership than an MBO (although alternative incentives may be available to address such concerns)?

The changing tax landscape may also have an impact. In 2014 when EOTs were introduced, Entrepreneurs Relief (now called Business Asset Disposal Relief or BADR) enabled an effective CGT rate of 10%, and was capped at £10m per seller. Following the October 2024 budget, the standard rate of CGT on shares was increased from 20% to 24%. BADR now only applies to the first £1m of gains, and the effective BADR tax rate increases from 10% to 14% on 6 April 2025, and to 18% from 6 April 2026.

In February 2025 we are hosting a joint workshop with Fiander Tovell on this subject.  If you would like to receive details of the free workshop, please email [email protected].

The Corporate team at Paris Smith have a lot of experience in sales to Management Buyout teams as well as Employee Ownership Trust sales, so if you need any further advice or have any queries, please speak to a lawyer in our Corporate team.

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