Employee ownership trusts for law firms

A modern approach to succession and exit planning

For many retiring law firm partners, finding a suitable exit route is challenging. Internal buy-outs can place an unbearable debt burden on junior partners, while trade sales can destroy the firm’s unique culture. The Employee Ownership Trust (EOT) has rapidly emerged as the most compelling alternative in the legal sector.

Selling a controlling stake of your firm to an EOT allows retiring partners to extract their value securely, protects the firm’s independence, and significantly rewards the staff. Most importantly, under current legislation, a qualifying sale to an EOT benefits from a 50% relief from normal Capital Gains Tax (CGT) rates, meaning that the effective CGT rate will be 12% which compares favourably to the standard rate of CGT of 24%, or 18% if the disposal were to qualify for Business Asset Disposal Relief (BADR).

It should also be noted that the 18% BADR rate only applies to the first £1 million of qualifying gains, whereas the amount of gain that can attract the 50% relief from CGT in a sale to an EOT is uncapped.

As the sole accountancy firm working in partnership with the Law Society, Armstrong Watson provides end-to-end financial management for law firm EOT transitions.

Structuring the EOT transition

Transitioning to an EOT requires careful financial engineering to ensure the firm generates the cash required to pay the outgoing partners without starving the business of working capital. As a founding partner of Law Firm Ambition, we guide you through the process:

Firm Valuation: We provide a robust, commercial valuation of the practice that will stand up to HMRC scrutiny.
Funding the Trust: We model the future cash flows of the firm to determine how the EOT will fund the purchase—whether through future profits, external bank debt, or a mixture of both.
HMRC Clearances: We secure the necessary tax clearances from HMRC prior to the transaction, providing the outgoing partners with absolute certainty regarding their 50% relief from CGT.
Staff Remuneration: We advise on how to utilise the EOT structure to pay tax-free bonuses to your fee earners and support staff, boosting retention and morale.

Protecting your legacy

An EOT secures the future of the firm in the hands of the people who built it. We provide a tailored, fixed-fee proposal to manage the entire financial and tax structuring of your EOT, working seamlessly alongside your chosen legal advisors to execute the transition flawlessly.

Key contact

Andy Poole

Corporate Finance Partner

Contact Andy

Employee Ownership Trust: Key Pros and Cons

Below is a summary of the main advantages and disadvantages for law firms considering an Employee Ownership Trust structure.

It allows an alternative exit route for situations where there is no obvious third-party purchaser or succession plan. Some equity partners, particularly those approaching retirement or wishing to take on another challenge, may want to pass on the ownership of the firm to their employees.
The equity partners can benefit from a tax free sale of their share in the firm to the EOT if the transaction is structured correctly.
From an employee point of view, where a firm is controlled by an EOT there is a tax relief which allows it to pay annual bonuses of up to £3,600 per person income tax-free (but still subject to NI).
Many say there is a mental change when employees are involved in the ownership of a business. There is a shift that helps to drive success. Employees are more heavily involved, and it is shown to reduce absenteeism too.

Equity partners will not always receive all the money for the sale immediately. Often they will receive a portion upfront, this amount being funded by existing cash reserves in the firm or through utilising existing bank facilities and/or by taking out new bank borrowings – either in the name of the firm, or more likely the EOT with a guarantee provided by the firm or, in some instances, the former equity partner(s). Any remaining consideration would be paid to the partners on a deferred basis over a number of years with funding being provided by the firm. There are clearly risks involved in selling a business to an EOT.
It is not always easy to determine the value of the business. It is important that the owners and the trustees of the EOT agree on a fair market value for the firm, which is affordable for the EOT, and indirectly the firm. Servicing too high a price can potentially put too much strain on the working capital of the business. A lack of working capital to reward employees because of the high loan repayments can work as a disincentive.
The law firm will need to incorporate into a limited company prior to the sale to an EOT.
Whenever a law firm’s structure or ownership changes, there is a need for it to apply to the SRA to become an Alternative Business Structure. Whilst the SRA are familiar with EOT ownership structures, this can add time and costs to the switch in ownership.
Whilst an EOT ownership structure can solve the dilemma of how the existing partners exit from the firm, it can prevent future employees who aspire to equity ownership from achieving their aim.

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