What Could Possibly Go Wrong with an EOT? Part 3: Legal Pitfalls
Transitioning your business to an Employee Ownership Trust (EOT) can be an incredibly rewarding move, but it’s not without risks. While an EOT offers stability, tax advantages, and a lasting legacy, the process is complex.
Without proper due diligence, business owners can find themselves facing unexpected legal, financial, and operational challenges. Understanding what could go wrong—and taking steps to mitigate these risks—is crucial to ensuring a smooth and successful transition.
This blog is part of a 3-part series, with this third and final article focusing on legal pitfalls. You can read the first and second parts in our blogs – Part 1 covering the Successor Team
and Leadership Potential Risks and Part 2 looks at the Impact of Poor Business Financial Planning.
It is wise to prepare your EOT well for possible legal pitfalls, as these tend to be complete ‘deal stoppers’. The legal issue might be concerning proper legal title to your shareholdings, the impact of hidden clauses in significant commercial contracts, legal action threatened or suspended or even the lack of a tested business continuity plan. So here are some of the legal pitfalls to check into:
Share Ownership Disputed
Unclear agreements or verbal promises can lead to fundamental misunderstandings and potentially a key member of the leadership team leaving. In addition, if your business has had a share ownership change, then we strongly recommend having this reviewed by the right corporate lawyer (we work with several excellent corporate lawyers) to check whether it is validly legal and not ‘void’. Lack of clear ‘title’ over shares is one of the key causes of deal delay and significantly increased deal costs.
Major Contract Issues
A change of control clauses in a significant customer or supplier contract may be used by the other party to renegotiate the commercial relationship to the detriment of the new ownership.
Forgotten Legal Challenges
Overlooking key legal risks, such as intellectual property disputes, complying with regulations, or not fulfilling contractual obligations can result in costly consequences down the line. The founder may well be aware of these hidden risks, but the new leadership needs to be fully briefed on any ‘skeletons in the closet’!
Lack of Business Continuity Plan
Without a solid plan in place, unexpected events, such as your premises flooding, your systems being hacked, key personnel leaving or operational disruptions, can put the entire business at risk.
Case Study
When reviewing the preparedness for sale with one client, the review of a prior share transaction identified that the transaction was void, meaning the founder still had that person as a shareholder in the business. This led to a protracted re-negotiation with the ‘former’ shareholder to buyback their shares, which meant about a year’s delay on the deal, and considerable unwanted legal fees. In addition, when performing our Exit ReadiMap diagnostic on another client, we discovered a key supplier relationship had no formal contract or documentation; this review enabled the client to document the relationship in a robust agreement, preventing this from becoming a ‘deal stopper’.
The Key to a Successful EOT Transition
A well-executed Employee Ownership Trust can provide lasting benefits for both business owners and employees—but only if the transition is managed correctly. Due diligence is the key to avoiding costly mistakes, ensuring financial security, and setting up a governance structure that works.
At vfdnet, we help business owners navigate the EOT process with confidence, ensuring every key stakeholder’s view is accounted for, trustees go in with their eyes wide open, and every opportunity is maximised.
With our Grand Bargain tool implemented at the start of the process and our many years of experience project managing EOTs with EOT lawyers you’re in safe hands.
If you’re considering an EOT and want to make sure your business is set up for success, set up a call with James Shand today, with no obligation and in total confidence.
We’re here to help you make informed decisions, protect your legacy, and achieve the best possible future for your business, your employees and you!