The role of lenders in the transition to employee ownership

Employee Ownership Trusts (EOTs) are for many still “the new kid on the block” having been introduced in tax legislation in 2014 to encourage more businesses to transition to employee ownership.  However, they continue to grow in popularity as a succession model for business owners with the Employee Ownership Association reporting that there are now approximately 2,470 employee-owned businesses in the UK and around 58,000 employee owners now sharing in their organisation’s success. In this month’s article, we consider the funding requirements of corporate customers when transitioning to employee ownership.

In the sixth article in our series to be published throughout 2025, our tax and employee ownership specialists consider the funding requirements of corporate customers when transitioning to employee ownership.

What is an EOT?

An EOT is a special type of discretionary trust which is established by a company for the purpose of acquiring a controlling interest in that company.

The trustee of the EOT holds the shares on the terms of the trust deed for the employees of the company, who are the beneficiaries of the trust. This gives the employees indirect ownership.

Following a sale to the trustee, the day-to-day operation of the trading company continues to be carried out by the board of directors of the trading company. The role of the trustee is to oversee the board of directors and the overall business strategy in the interests of the employees.

What requirements must a trust satisfy to qualify as an EOT?

There are a number of statutory conditions which a trust has to satisfy in order to qualify as an EOT. These include:

• a requirement that the company whose shares are acquired is either a trading company or the parent company of a trading group;
• a requirement that the trust acquires a “controlling interest” in the company; and
• a requirement that the assets of the trust are used only for the benefit of the company’s employees and that the employees benefit on the same terms.

A number of changes to the rules relating to EOTs were announced at the Autumn Budget 2024.  These include the introduction of a trustee independence requirement (preventing selling shareholders (or persons connected with them) from retaining control of the company post sale), a requirement that the trustee be UK resident and a requirement that the trustee takes all reasonable steps to make sure that they don’t pay more than market value for the shares in the company.

Our specialist, and experienced, employee ownership lawyers have written a series of articles about EOTs, if you’d like to learn more please visit our Employee Ownership Trusts page.

Is there a role for banks to play in the transition to employee ownership?

Yes there is.  Financing the sale price (which must not exceed market value) is one of the key challenges of the employee-ownership model since the EOT trust fund will typically consist only of a nominal amount of cash prior to the acquisition.

If the trading company has sufficient distributable reserves then these can be used to fund the sale to the trustee with the company making a contribution to the trustee for this specific purpose. However, often there won’t be sufficient cash to fund the acquisition in full on completion (and if there are significant reserves then the company may need advice as to whether it still meets the EOT trading requirement) in which case the funding challenge is typically addressed in one of two ways – by the use of a vendor-finance structure or through debt financing. 

Vendor finance means that the selling shareholders agree to receive all, or a proportion, of the sale consideration as deferred consideration paid by the EOT in instalments over a number of years (typically 4 to 7) following completion. In this structure, each instalment of deferred consideration is funded by contributions made to the EOT from profits of the company.  It is often the case with vendor finance that flexible repayment terms are set out in the share purchase agreement as payment of the deferred consideration relies on the trading company having sufficient distributable profits at the relevant time to make the contributions to the EOT.

Alternatively, borrowing money from a bank or other finance provider may be the preferred financing route.  Debt-financing can enable the EOT to pay the full consideration to the selling shareholders on completion and is often sought where the parties intend to pay the selling shareholders faster than future profits will permit.

In a debt-financing structure, the EOT or the trading company (depending on which entity is the borrower – see below) is liable to repay the money borrowed, plus interest, over a set period.

It is often the case that the sale consideration is funded by a combination of each of the elements discussed above and the size of the transaction may dictate the lending requirements. Medium to larger transactions may involve traditional bank funding and subordinated debt from specialist lenders or, if necessary, institutional lenders.

Should the bank lend to the EOT trustee or the target company?

Whether the bank lends to the EOT trustee or to the target company is a key question. As the trustee’s only asset will be the shares in the target company it will not have any other assets which it can leverage as security. It is possible for the lender to ask for, and be given, a charge over the shares in the target company held by the EOT as security for any loan funding to the EOT although the bank will want to ensure that the EOT will be able to repay the loan and applicable interest (from dividends or contributions made by the target company to the EOT).  A lender is therefore likely to require a guarantee from the target company and this can be an issue for the directors of the target company who are under a duty to act in the best interests of that company. 

It is possible for the lender to lend directly to the target company which in turn contributes the funds to the EOT to pay the sale consideration to the selling shareholders. Again, this can result in directors’ duties issues and security would need to be given over the target company’s assets.

A lender will have less protection than in the case of a company owned by individual shareholders where personal guarantees can be sought.

It will be essential to review the terms of any loan, in particular, any provisions in the facility agreement that permit the lender to take control of the company in the event of default as this may risk the “controlling interest” statutory condition failing to be met and consequently the tax relief being lost triggering unintended (and potentially unfunded) tax liabilities.

What will lenders want to know about the EOT structure?

Each lender will have its own requirements but we would expect a lender to require:

• a full market value report;
• to understand what, if any, substantial assets are on the target company’s balance sheet;
• evidence of a robust and proven cash flow;
• that repayment of any loan is demonstrably affordable;
• the trading company to have strong internal controls that mean the company is flexible and can anticipate and adapt in its sector;
• evidence that the management team is balanced and a strong team that can move the business away from dependence on the selling shareholders;
• confirmation of whether any additional funding will be needed in the short term following the transition to employee ownership (eg if machinery needs to be replaced then this should be factored into the arrangements as post-sale, future expense and growth may be limited until the EOT is debt-free);
• a legal opinion that the trust deed and corporate structure (including the arrangements set out in the transition documentation) meet the current legislative requirements to qualify as an EOT;
• input into the transition documentation, in particular the share purchase agreement, such that it is properly negotiated and includes only reasonable seller protections and necessary buyer protection in the form of warranties and indemnities; and
• an understanding of any pre-sale tax planning and confirmation that it has been carried out tax efficiently (we see more and more trading groups reorganise before transition so that selling shareholders can retain perhaps a standalone arm of the business or properties from which they can derive an income in retirement).

Of course, the transition to employee ownership itself is a major change to any business and lenders will want to know that there is headroom/contingency for immediate changes.

Given the information that will need to be shared between the target company, selling shareholders and lender, the key to a successful outcome will be early engagement.

TLT comment

Not all banks are major players in the EOT space although this is evolving and with the increase in popularity of EOTs more lenders are becoming familiar with the construct. Certainly, challenger banks and specialist lenders are increasingly taking advantage in this space. The main reason for this is that an EOT does not neatly fit into traditional lending models; the requirement is often more heavily weighted to a cash flow loan which has a higher risk score than lending against fixed assets so it is often alternative finance providers especially those with knowledge of the SME market that fill the gaps in lending provision. 

As EOTs work to be “debt free” having paid off the selling shareholders, it is common for loans to be refinanced giving banks and financial institutions repeat business.

TLT has been involved in a number of EOT deals in recent years in which external funding has been made available, acting for either the lender or the borrower (the target company or the EOT trustee as buyer).  We find it encouraging that bank funding is increasing and that it also brings financial and governance benefits to the process.

Emma Bradley, Partner in our Tax Team says: “Bank funding for EOTs will continue to be critical as an alternative to vendor finance, as the employee ownership sector grows and matures financial institutions established in this space will reap the benefits of repeat lending.”          

How can we help?

TLT has been a leading firm active in the employee ownership sector for a number of years.  Our specialist, and experienced, employee ownership lawyers have a diverse range of clients in England, Wales, Northern Ireland and Scotland.

Our Tax, Incentives and Banking teams have a wealth of experience providing commercial and insightful advice to national and international banks, building societies, other funders and institutions in the financial services sector.    We also provide insightful strategic direction to employee-owned businesses at every stage of their journey and have led a number of the most high-profile employee ownership transactions within the UK.

If you are interested in discussing any of the topics covered in this article, get in touch with our Tax and employee ownership specialists below. 

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at August 2025.  Specific advice should be sought for specific cases.  For more information see our terms & conditions.