The evolving role of Private Equity in Employee Ownership Trusts

In recent years, the concept of employee ownership trusts (EOTs) has gained significant traction as a tax-efficient exit strategy for business owners in the UK. As the landscape of business ownership and succession planning continues to evolve, EOTs have emerged as an increasingly attractive option, offering a range of benefits for both business owners and their employees.

The intersection of private equity investment, EOTs and other employee stock ownership plans (ESOP) is becoming an increasingly prominent trend, and institutional investors are recognising the opportunity to invest in EOT owned companies to realise a return for investors, offering access to growth capital which would not otherwise have been available, while preserving the core principle of employee ownership.

The Role of Leveraged Finance

In most cases, EOTs may have limited upfront capital to purchase the business owner’s shares, leading to a phased payment plan, often funded initially by a comparatively small debt financing and thereafter by the company’s future profits. In implementing an EOT transaction, the traditional private equity financing approach will therefore not be appropriate. However, if the payment of deferred consideration is laboured and there is a sense that the EOT structure is not the ’best fit’ for the underlying business it is important to recognise the need to explore alternative structures. Possible alternative structures may accelerate the receipt of cash consideration due to vendors, whilst also allowing them to manage the associated tax implications and ensure a fair and equitable deal for all parties involved. This may include revisiting the private equity market and considering simple contractual (over structural) debt subordination. Any transaction which reduces the EOT’s majority shareholding needs to be carefully considered, and the changes to the EOT legislation as announced in the Autumn budget only heightens the challenges which will be relevant.

Private Equity Investment in Employee-Owned Companies

With growing interest from private equity firms in examining options to unlock value from employee-owned companies, the original vendors and more relevantly the Trustee of the EOT (as controlling shareholder) should consider how future returns could be optimised. Private equity firms can offer the necessary growth capital to these businesses, while still enabling employees to retain a meaningful ownership stake. This presents an attractive option for mature EOT owned businesses and ESOPs wanting to explore new ways to settle any remaining deferred consideration from the original EOT transaction, crystallise a realisation event for the EOT beneficiaries (the employees) or take the business in a ‘new’ direction.

Beyond just providing capital, the involvement of institutional investors can also significantly benefit employees in these companies. Not only could they receive an immediate cash distribution by the EOT, which for many staff across the wider employee base could represent a significant and an unexpected amount of value, but they will also become part of a potentially accelerating equity growth story. Private equity capital in employee-owned companies can help catalyse organic and M&A-led growth, supported by sustainable debt financing and ultimately achieve greater value at a future exit event. This accelerated growth trajectory allows employees to realise the fruits of their labour in a way which is rarely envisaged when the EOT initially acquired control of the business.

Evolving EOT legislation and sustainable finance landscape

As the UK tax law relevant to EOTs evolves, impact-oriented private equity firms have an opportunity to align their investment strategies with the spirit of this model and benefit from structuring deals that include sustainable debt financing instruments, with socially driven KPIs, which can also drive reputational and pricing advantages.

While private equity investment will not work for every EOT owned company, it can provide a viable solution to the evolution of certain employee-owned companies. By leveraging sustainable financing to support EOT controlled companies, private equity can foster broad-based employee ownership, engagement, and a shared commitment to long-term business resilience.

Advisors play an important role in effectively navigating through the intricacies of employee-owned structures, as well as being able to maximise returns with debt and private equity funding. FRP Corporate Finance have recent experience of advising deals of this nature, so please do feel free to reach out if you would like to learn more.