Employee Ownership Trusts (EOTs) and SRA Approval: What Law Firms Need to Know

It was not that long ago that selling a law firm felt like an almost impossible task. Law firms had to be sold to other lawyers or other law firms, and that massively reduced the available options.

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Since the advent of Alternative Business Structures (ABS), the situation has gradually changed. Private equity investors in particular have been acquiring these recession-resistant, potentially high-margin professional services businesses. However, not every firm wishes to pursue the private equity or corporate investor route. Increasingly, another model has entered the conversation: the Employee Ownership Trust (EOT).

There are now significant numbers of UK law firms whose owners have sold a controlling interest in the business to a trust established for the benefit of their employees. In established firms, this can involve substantial upfront consideration, funded either from retained profits or through bank lending, where the business can sustain it. From that point onwards, the shares are held by trustees who manage the trust for the benefit of employees as beneficiaries. The former owners may, in some cases, continue to sit on the trustee board, but control must genuinely transfer to the trust.

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Why Do Law Firm Owners Choose an Employee Ownership Trust?

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Not every law firm has the option of a third-party sale, and some owners are concerned about the cultural impact of external investment. For many, succession planning is the real driver. An EOT can provide a structured and orderly exit route, particularly where there is no obvious internal successor with capital to buy in.

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A major attraction of an Employee Ownership Trust for law firms is the tax treatment. Where the statutory conditions are satisfied, the sale of a controlling interest to an EOT can be exempt from capital gains tax. In addition, employees of an EOT-owned business may receive income tax-free bonuses of up to £3,600 per year.

These tax advantages are conditional and depend on meeting strict structural requirements, including:

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• The company must be a trading company at the time of sale.

• The EOT must acquire a controlling interest (more than 50%).

• The trust must operate for the benefit of all eligible employees on broadly equal terms.

• The former owners must not retain control after the sale.

The statutory conditions are detailed and technical. Specialist tax advice is essential to ensure the structure qualifies.

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The EOT market for law firms is still developing. Early experience suggests that, when implemented properly, employee ownership can strengthen long-term performance and staff engagement. However, it is not a short-term mechanism; it is a structural change to ownership and governance.

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How Do You Sell a Law Firm to an Employee Ownership Trust?

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There are two distinct workstreams in any law firm EOT project:

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1. The legal and tax structuring workstream – including drafting constitutional documents, designing the trust structure and ideally obtaining HMRC clearance in relation to the tax treatment.

2. The SRA authorisation and regulatory workstream.

For SRA-regulated firms, the regulatory pathway is critical and often underestimated.

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SRA Approval and ABS Licensing for Law Firm EOTs

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In order for a law firm to implement an Employee Ownership Trust structure, it must be licensed as an Alternative Business Structure (ABS). This is essential because the shares will be held by a trust, which is not itself a lawyer or a traditional recognised body.

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In practical terms, this usually means the firm must be a limited company. Traditional recognised bodies that are not licensed as ABS firms cannot have their shares held by a non-lawyer trust structure.

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If the firm is not already an ABS, the conversion process should begin early. ABS applications can take several months, and delay at this stage can materially impact the overall EOT transaction timetable.

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There is sometimes a misconception that SRA involvement is optional or limited. It is not. An EOT transaction involves a change in ownership and control, and therefore requires SRA approval.

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Applications for ABS licensing in connection with Employee Ownership Trusts remain relatively novel. The SRA Authorisation team continues to encounter these structures more frequently, but careful presentation remains essential. A clear understanding of how ownership interests are assessed in an ABS law firm is critical to avoiding confusion over who requires approval.

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Who Needs SRA Approval in an EOT Law Firm Structure?

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In most cases, the trustees of the Employee Ownership Trust will require SRA approval as owners or managers of the ABS, unless an exemption applies because of their regulatory status.

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There was historically some anxiety about whether every employee who benefits under the trust might be treated as an “owner” requiring SRA approval. In practice, it is now reasonably well established that employees who benefit indirectly from the trust but do not exercise control are not typically treated as owners for approval purposes.

However, this is not a point to leave ambiguous. It is important to be explicit with the SRA about:

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• how the trust operates

• who exercises control

• who holds voting rights

• who requires approval under the SRA Authorisation Rules

Simply submitting the structure and allowing the regulator to interpret it without explanation risks delay and misunderstanding. In EOT applications, we provide a detailed covering submission explaining precisely who requires approval, why, and under which provisions. A clear structure diagram and the relevant constitutional documentation support this.

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Applications must demonstrate suitability, integrity and an understanding of regulatory responsibilities. This is usually done through the relevant SRA approval forms, like other SRA authorisation or ABS applications. None of this makes Employee Ownership Trusts unworkable for law firms. Quite the opposite. When properly structured and clearly presented, they are entirely achievable. With realistic timelines and proper preparation, the SRA approval process is manageable. To date, every EOT-related SRA application I have worked on has been approved.

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Governance, Control and the Long-Term Commitment of an EOT

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The more significant “catch”, if there is one, is not regulatory but structural. An EOT is a long-term ownership commitment. It requires:

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• cultural alignment

• robust governance

• carefully drafted constitutional documentation

• trustee appointments that are credible and sustainable

By definition, the former owners are selling a controlling majority. The firm must therefore be capable of operating sustainably without dependency on its founders. If the business cannot stand on its own, staff expectations may not be met and deferred consideration to the former owners may be at risk.

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Trustee selection requires careful thought. Governance arrangements must be clear, workable and resilient. We strongly recommend engaging specialist legal advisers experienced in Employee Ownership Trust documentation and can make introductions where helpful.

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For firms willing to approach the process properly, the rewards can be significant: a tax-efficient succession plan, preserved culture, motivated employees and a stable ownership model that does not rely on the next generation having capital to buy in.

The regulatory question is rarely whether the SRA will need to approve an EOT structure. In practice, it will. The real issue is how clearly the structure is explained and how well the application anticipates regulatory questions.

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With the right preparation and a properly structured ABS application, SRA approval of a law firm EOT can become a straightforward and ultimately successful process.