The John Lewis effect: Why more channel firms are becoming employee-owned

Can EOTs challenge the dominance of trade and private equity exits in the industry? CRN investigates

Just imagine if there was a tax-efficient way for business owners to exit their company that also protected jobs, boosted staff morale and increased productivity.

Well, that's exactly what's being offered by a relatively new ownership model that's beginning to catch on in the IT channel, according to its proponents.

The concept of the Employee Owned Trust (EOT) was introduced by the government in 2014 to encourage more business owners to set up a corporate structure similar to that of John Lewis (albeit with employees holding an indirect, rather than direct, stake).

According to the Employee Ownership Association (EOA), 2021 was a record year of growth for the model, with 285 new Employee Owned businesses created. The total stood at 1,030 in June 2022, it said.

And several EOTs have popped up in the UK IT channel over the last 12-18 months.

In each case, the outgoing owners were eager to safeguard the welfare of employees by handing ownership to them rather than a trade or private equity buyer.

Employee power

Ipswich-based Getech, a £74m-revenue reseller and distributor of edtech and end-user computing, set up an EOT last October after its three owners were alerted to the model by their accountants.

"We were all 55-plus, with one eye on an exit strategy. We'd had lots of approaches - trade sales, private equity - and some had got very, very close," sales director Guy Watts told CRN.

"But the one thing that became very apparent was that, as soon as you sign on that dotted line, you effectively lose control of the company and the acquirer can do whatever they like."

Watts said he and his fellow directors first sat down with their accountants on a hot day in June 2020 during the first wave of Covid.

"As we started getting the valuations through and to understand more about what an EOT could deliver, it just became an absolute no brainer," he said.

Getech's three owners, including Watts, are using the EOT model to gradually step away from the business as a new senior leadership team is put in place.

Distributor Target Components became an EOT in June 2022, meanwhile. Its 60 employees now indirectly hold a 75 per cent stake in the West Yorkshire firm, with its two previous shareholders, Paul Cubbage and Ian Prescott, each retaining a 10 per cent stake.

Target's recently appointed MD, Michael Lawrence (pictured below), holds a five per cent stake in the business but is also a member of the EOT.

"I share the benefits of being a member of an employee-owned trust as well - I'm the one with a foot in both camps," he told CRN.

Although Lawrence admitted he wasn't familiar with the concept of EOTs before joining the business in March, he said the process had gone smoothly for Target so far.

"It's definitely an emerging trend in business ownership," he said.

"The fact that Paul and Ian have retained a share in the business and therefore a buy in in its future success, is a key reason why it's gone through quite smoothly.

"A lot of work gets done by the lawyers. It's a paperwork-intensive process because you've got the creation of new companies, the filing of those companies, the various sales, documents and share certificates. You've got 30 to 40 documents, all of which have to be done in the right order to be valid.

"But it's been taken really positively by the people in our business."

Getech and Target aren't the only EOTs in the UK IT channel.

The MD and owner of Microtech, Chris McMail, handed a 74 per cent stake in the Scottish IT support outfit to its 70 employees in September 2021.

After taking the decision to explore strategic options for his business, McMail said his primary consideration was that any action taken would not compromise Microtech's staff (pictured below).

"It soon became apparent that any sale of the business to a third party would result in drastic changes to the company operations, including potential relocation and possible job losses," he said in a company announcement at the time.

"When the proposal of transitioning to an EOT was suggested, I knew this was the best way to secure the company's position in Ayrshire."

Public sector IT services provider Agilysis became an EOT as long ago as 2015, while Welsh Microsoft partner Pro-Networks adopted the model in March 2022, meanwhile.

Becoming an EOT

Under the EOT model, the existing owners sell their shares to a new Trustee Company that represents the employees. The indirect ownership EOT model means the employees do not own shares in their employer company directly, but instead are beneficiaries of the trust (which must hold a controlling interest to qualify).

The two parties will then jointly engage an independent expert to value the company.

"The valuation is put through its paces by numerous accountants and advisors, and then goes up in front of HMRC," Watts explained.

"We spent a lot of time ensuring that the proposition, our trading history and our projections moving forward were rock solid. It was all very conservative, realistic and attainable."

Lawrence said the upfront sum Target's two shareholders received was financed by a mix of excess cash within the business and invoice discounting.

"But it's been taken really positively by the people in our business," Michael Lawrence, Target Components

Cubbage and Prescott will receive the rest of the purchase price via loan notes, Lawrence said.

"Over the next ten years, Target Components EOT Ltd owes Paul and Ian a certain amount of money in order to purchase their shares in the business," he explained.

"Targets Components Ltd doesn't change - that's our trading company. Target Components EOT Ltd is what's been created. No employee has to contribute anything to the fund, and no employee - even the employee trustee who is a director in that business - has a liability in that business, so they can't share in any losses."

Staff satisfaction

Alongside the most obvious mooted benefit of safeguarding employees, proponents of the EOT model claim it can increase staff retention and unlock greater performance and productivity.

According to the EOA, EOTs also tend to be more socially responsible.

Although the previous business owner could potentially achieve a higher valuation through a competitive sale process, selling to an EOT may be quicker and easier, and means they will avoid paying capital gains tax or inheritence tax. And EOTs can also pay annual bonuses (of up to £3,600) to employees which are free of income tax.

Lawrence at Target said the distributor has opted to share its profits with employees via an annual, tax-free bonus.

"We already did a profit share scheme at Target. My advice is to consider that, because it creates a financial bind and incentive," he said.

"There are some financial benefits and some less tangible benefits," Lawrence added.

"The biggest thing for us is that the employees like the job security. The second part is that as employee owners they feel they have more of a say in how things are done."

Watts (pictured above) highlighted greater staff inclusivity as a major benefit of becoming an EOT.

"We were always a very inclusive organisation, which is one of the reasons we opted for an EOT. But since [becoming an EOT], we've set up a staff council, which gives staff more of a formal platform to raise issues and make suggestions," he said.

"We had almost an election, with people campaigning and putting forward what their messages would be, and it was a really engaging process for the whole company. Since the back end of last year, there's been some great suggestions put forward that otherwise might not have seen the light of day.

"There are some very tangible benefits [in terms of tax], but I think it's just the fact that everyone knows the decisions they make will benefit them directly in the long term."

EOA uptake

According to the EOA, the employee ownership sector has more than doubled in the past three years, with the number of UK employee-owned businesses standing at 1,030 as of June 2022 (of which 80,000-strong John Lewis is the largest).

The model is most popular among professional services firms (38 per cent), with construction (13 per cent, manufacturing (13 per cent), wholesale/retail (11 per cent) and IT/comms (nine per cent) rounding out the top five.

Target joined the EOA after becoming an EOT in June, and Lawrence last week attended his first EOA networking event (see above).

He left with an impression of a nascent but growing business ownership movement.

"When I listened to the conversations of people who attended but weren't necessarily aware of what it is, there were a lot of basic fact-finding questions they were asking. That suggested to me that, as a method of business ownership, it's still very immature," Lawrence said.

"When I joined Target, the transaction was in the middle to latter stages, and it was something I had to read up on.

"But I see more and more examples of EOTs in news feeds. There was a business announced in Castleford - a car dealership - last week, and an old colleague who now runs a furniture manufacturing business recently completed their deal."

An EOT model may be less appropriate for companies with transient workforces or less loyal employees, Watts cautioned.

"Being quite a rural organisation, a lot of people that work here live locally and a lot of them have worked here for 25 years or more. So I wanted to make sure that, whatever route we went down, staff were core to it," he explained.

"The day that I made the announcement to the staff was probably one of my proudest days as a business owner," Guy Watts, Getech

"For companies that have multiple offices and people who move from job to job, maybe it wouldn't be quite so beneficial. But then again, if that company was an EOT, would staff stay longer because they feel more part of the organisation?" .

Lawrence, meanwhile, said EOTs may work less well in instances where the owner-managers have used it to generate the highest possible exit sum for themselves.

"I know examples where the valuations were at the absolute top end and the owners really took as much value out as they could. And then in most cases, you tend to find that the owner leaves the business," he said.

"The majority of people who sell, I think, retain some sort of vested interest. When we have board meetings at Target, I talk to Paul about the numbers and performance - he retained that interest because he ran it for 20 years."

Words must be matched by actions, Lawrence added.

"We revised all our benefits to try to give more back to the employees. You need to treat them truly as owners," he explained.

"But I imagine some organisations get that disconnect, which could be quite dangerous. For me it's about embedding it in your culture."

The perfect exit option?

Until relatively recently, owner-managers in the channel weighing up an exit have faced a choice between a trade sale, PE sale or MBO.

Could an EOT present a more attractive option?

Watts at Getech claimed EOTs are an inherently sounder option for those concerned about the long-term wellbeing of staff.

"The record books are littered with disastrous buyouts. This just seems like a perfect way for existing shareholders to transition," he said.

"The day that I made the announcement to the staff was probably one of my proudest days as a business owner, as we were effectively saying ‘we think so much of you as staff that we're passing the company on to you'."

"It's an interesting modern alternative to a management buyout, probably where the owner wants to realise some of their some of their capital that they've invested into the business, but maybe doesn't want to really sort of release full control of it," Lawrence concluded.