Employee Ownership Trusts – a credible exit strategy
11 October 2022
Introduction
An employee buy-out via an Employee Ownership Trust (EOT) is increasingly viewed as an option amongst those considering succession and exit of their business. To date it has been favoured by those in professional services, the construction sector and those running family-owned businesses but EOTs can present an attractive and innovative ownership structure for other sectors too.
What is an Employee Ownership Trust?
An EOT is a form of Employee Benefit Trust (EBT) and a means of achieving employee ownership. EBTs are trusts established to hold assets and provide benefits for the employees of a company or group of companies.
For an EBT to be an EOT it needs to meet certain conditions including the requirement for the EOT to hold a controlling interest in the relevant company’s share capital and to treat beneficiaries on the same terms.
How prevalent are EOTs?
According to data collected by the Employee Ownership Association (EOA) the sector includes 1030 businesses as of June 2022. The sector has doubled since 2020. 139 new Employee Owned businesses were created in 2020 while 2021 has been a record year with 285 new Employee Owned businesses created.
Benefits for businesses and the wider economy
The EOT tax reliefs are rooted in a political desire to introduce more diversity of ownership into the UK economy. The benefits the Government seeks are improved UK productivity and more resilient regional economies.
An EOT is also attractive for those business owners who would like to exit but for whom there is little prospect of sale to a third party perhaps due to the sector or geographic area in which they operate.
EOTs offer significant tax advantages both for the employer and employees. No Capital Gains Tax (CGT) charges will arise on the transfer of shares from qualifying shareholders to an EOT. This represents an attractive exit for shareholders who would otherwise suffer CGT.
A company that is owned by an EOT can pay up to £3,600 each year free of income tax via a qualifying bonus scheme for its employees.
The evidence suggests that employees in EO businesses feel more engaged and rewarded by this more inclusive model of corporate governance. As a result employee ownership can help with staff recruitment and retention at a time when many businesses are faced with dealing with the ‘Great Resignation’ and attracting and retaining Millennials.
Pricing and funding
Assuming there is a sale to the EOT, as opposed to a gift of shares, the price at which the shares are sold should be informed by a professional valuation of the company. Whilst some EOT deals are financed they tend to be vendor backed.
The principal difference between a sale to an EOT and a sale to a third party buyer is the availability of the cash to fund the purchase. On a typical sale to a third party buyer, the buyer will often make an immediate cash payment on completion with, perhaps, a proportion of the consideration payable on a deferred basis (whether or not on an earn-out formula). However, an EOT, once set up, is unlikely to have any material funds. The purchase is therefore funded via gifts of cash from the employee-owned company. In practice, a significant part of the consideration paid by the EOT to the sellers on a deferred basis, funded out of future gifts of cash which the EOT receives from the company’s trading profits.
Conclusion
Employee Ownership via an EOT provides a credible exit strategy with significant tax advantages if the qualifying conditions can be met.
Birketts are specialist advisors in this field. Contact Lisa Hayward for further information.
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Lisa Hayward
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at October 2022.