Employee ownership trusts: an underused exit for business owners

Why business owners should still consider employee ownership trusts

Employee ownership trusts (“EOTs”) have enjoyed a surge of popularity in the last few years. Specific legislation to encourage employee ownership was first introduced by the Finance Act 2014, and the use of EOTs rose sharply from the early 2020s onwards. 

 Recent reforms, however, have changed the landscape: the EOT route remains attractive, but the rules now place greater emphasis on genuine employee ownership, independent governance, market-value pricing and ongoing compliance. 

The roster of companies owned by EOTs includes Richer Sounds, Go Ape and Aardman Animations, the creators of Wallace and Gromit. This is no surprise, given that EOTs can still offer a succession route that benefits both selling shareholders and employees. However, following reforms announced at the Autumn Budget 2024 and further changes that took effect from 26 November 2025, they can no longer be described simply as a fully tax-free exit. The main legislation covering the taxation of employee ownership trusts is in the Taxation of Chargeable Gains Act 1992 Part 7 ss 236H to 236U and HMRC’s guidance can be found here. 

What is an employee ownership trust?

An employee ownership trust or EOT is a trust established for the benefit of a company’s employees, with the trustee often incorporated as a company limited by guarantee. The EOT trust acts as the vehicle that purchases a target company from its owners at the outset of the transaction, and then holds the shares and acts as the controlling shareholder of that company after completion.

In EOT transactions, the business owners typically sell to the EOT for a ‘fair’ price, as determined with an independent valuation. The consideration for the sale is normally in the form of cash and loan notes, which ultimately derive from the cash generated by the target company.

Where to begin?

There are now several key conditions and practical safeguards which must be satisfied for a shareholder to be eligible for the tax benefits of selling to an employee ownership trust:

1. The target must be a trading company or the holding company of a trading group.
2. The target must have a minimum proportion of employees who are not the owners or connected persons (such as spouses).
3. The trustee of the EOT must hold a controlling interest in the target. This means that it should hold more than 50% of the company’s ordinary share capital, hold the majority of the voting rights in the company and be entitled to more than 50% of the profits, among other requirements.
4. The EOT must be established for the benefit of all employees on the same terms, though the amounts paid to employees can vary by reference to remuneration, length of service or hours worked.
5. The selling shareholder must generally be an individual or a trustee, not a corporate or institutional seller. Claims now require more information to be provided to HMRC, including details relevant to the sale proceeds and the employee base.
6. The trustees must be UK resident as a single body of persons at the time of the disposal and must continue to satisfy the residence requirement during the relevant post-sale period.
7. The former owners and persons connected with them must not retain control of the target through control of the EOT. In practice, this means careful attention must be paid to trustee composition, reserved powers and governance arrangements.
8. The trustees must take reasonable steps to ensure that the consideration paid for the shares does not exceed market value, and that any interest on deferred consideration is commercially justifiable.

The process of this sale typically takes between three to five months to complete. This involves getting the target company valued, obtaining tax clearances where appropriate, drafting the sale documentation and setting up the EOT structure. Since the recent reforms, the valuation and governance workstreams have become more important: trustees should be able to evidence that they have considered market value, the reasonableness of any deferred payment terms and the independence of the trust’s decision-making. 

EOTs can even be combined with an enterprise management incentive (EMI) scheme, which can be a particularly helpful way of keeping the management incentivised while a lot of the cash generated by the business is being used to pay the purchase price to the owner.

EOTs after the reforms

There remains a clear reason for EOTs being attractive: they can provide a succession route with meaningful tax advantages and a lower execution risk than a third-party sale. However, the tax position has changed and has become less favourable. For disposals completed before 26 November 2025, a qualifying sale to an EOT could benefit from full capital gains tax (CGT) relief. For disposals made on or after that date, only 50% of the qualifying gain are exempt from CGT, with the remaining 50% chargeable under the normal rules. 

Although reduced, the tax advantages remain favourable when compared with an ordinary disposal with gains taxed at up to 24%, but it is a material change from the previous full exemption. The chargeable element will need to be factored into the transaction economics, particularly where the seller is being paid largely by deferred consideration funded from future profits. There is also a limited exemption from income tax (but not national insurance contributions) on bonus payments of up to £3,600 per year for the target’s employees. The bonus rules have been made slightly more flexible by allowing directors to be excluded from certain tax-free bonus awards, where appropriate. 

The reduction in CGT relief also raises a broader question for some business owners. Following the reforms, a qualifying disposal to an EOT will generally result in an effective CGT rate of 12% (ignoring other exemptions and reliefs) compared with the 18% rate available under Business Asset Disposal Relief on qualifying gains within the £1 million lifetime limit. For some owner-managers, particularly those of smaller businesses, the tax saving may not on its own justify the costs of implementing an EOT, the governance framework required for trustee independence, and the ongoing compliance obligations that follow completion. In those cases, the non-tax advantages of employee ownership and succession planning may become the more significant drivers of the decision. 

The reforms also provide greater legislative certainty for contributions made by a company to the EOT to fund acquisition costs, including deferred consideration and related costs, although the detailed conditions should be checked carefully in each case. 

Outside the tax benefits, there remain significant non-tax related advantages to owners exiting to an EOT, and indeed several substantial employee-owned companies existed long before the EOT legislation was introduced, such as the John Lewis Partnership and Arup Group. Many owners like the idea of passing the benefit of their business to its employees, who are often the ones who have contributed to the value in the business in the first place. 

Additional legal work is needed to set up the EOT, but the sale process itself can also be simpler than on a trade sale. Minimal due diligence is required by the buying entity, there is relatively little negotiation of deal terms, and the risk of a failed sale is low. That said, the process involves getting the company valued, considering whether HMRC clearance should be sought (for example, in relation to the transactions in securities rules where the company will fund the EOT’s acquisition of the shares), drafting the sale documentation and setting up the EOT structure.  

The exiting shareholder can stay in the management of the business after a sale to an EOT. It is not uncommon for a seller to stay on as a director of the target and wind down their day-to-day involvement with the business over a number of years as their loan notes are redeemed, while control over the business passes to a new management team to benefit as employees through the EOT’s ownership. 

From an employee’s perspective, in addition to the tax advantage mentioned above, the main advantage of the arrangement is that the business will be run for their benefit and they get to share in the profits generated. This is often very attractive compared to the potential upheaval that can follow trade sales.

Disqualifying events

No new claim for relief may be made, and relief previously given may be withdrawn, if certain events occur during the relevant post-disposal period. The recent reforms have extended the vendor clawback period so that disqualifying events in the first four tax years following the tax year of disposal can cause the seller’s CGT relief to be withdrawn. Disqualifying events occur when: 

• the target ceases to meet the ‘trading requirement’; 
• the EOT ceases to meet the ‘all-employee benefit requirement’; 
• the EOT fails to satisfy the trustee independence requirement;  
• the EOT ceases to meet the ‘controlling interest requirement’; 
• the ‘participator fraction’ exceeds two-fifths; or 
• the trustees act in a way which the trusts, as required by the ‘all‑employee benefit requirement’, do not permit; or  
• the EOT trustees cease to satisfy the UK residence requirement. 

Where a disqualifying event takes place after the vendor clawback period, the trustees may instead be treated as making a disposal and immediate reacquisition of the ordinary share capital of the target company, potentially triggering gains. The extended clawback rules mean that sellers, trustees and the company will need to monitor compliance for longer than was previously the case.

The risks to be aware of

From an owner’s perspective, a key disadvantage of this route is that they will often have to wait a number of years to be paid out in full (frequently five years or more). This is often because the target is unlikely to be able to fund the full purchase price upfront from its own resources and it is currently uncommon for lenders to finance the gap, so the consideration can only be settled when the business has generated sufficient free cashflow for the EOT trustee to settle the deferred consideration. The reduction in CGT relief for post-26 November 2025 disposals also means sellers may face a tax cost before all deferred consideration has been received, which should be modelled carefully. 

This is especially an issue for a target company that does not consistently throw off cash, or whose value is a high multiple of earnings. The delay may be unpalatable, but many private merger and acquisition transactions have a sizeable part of the purchase price deferred or subject to earn-outs, so the benefits of EOT treatment often outweigh the delay. 

Another consideration is how the EOT route may also close off strategic buyers, who may be willing to pay a premium to the ‘fair value’ (e.g. for special synergies between the buyer and the target). 

For employees, the time taken to pay the business owner out may be frustrating. While the purchase price is outstanding, the bulk of the profits generated by the business will be passed to the EOT trustee to pay off the former owner, and not reinvested or paid to the employees. It is, however, possible to mitigate this downside by permitting some of the business’s profits to go to the employees, even if some of the purchase price is outstanding. 

Although there are a few disadvantages to this process, it is not surprising that EOTs have surged in popularity. Business owners can still achieve a succession outcome with reduced deal risk and due diligence stress, while giving employees a meaningful stake in the future of the business. However, the recent reforms mean that EOTs now require more careful planning, robust governance, defensible valuation work and ongoing monitoring than older commentary may suggest.

This article was first published by Tax Adviser in April 2023, and last updated by Boodle Hatfield in August 2026.