What are Employee Ownership Trusts?
Broadly speaking, an Employee Ownership Trust is a modified version of the well-known employee benefit trust structure, which is commonly used to facilitate a company’s transition to employee ownership. Subject to meeting strict qualifying criteria, a sale to an EOT should also provide a tax efficient exit option for the existing shareholders of a company.
What are the advantages of EOT ownership for the business?
The EOT structure permits employees to hold an indirect equity stake in the business, entitling them to share in any future profits which are realised. In my personal experience, this can have the following positive effects:
- Increased productivity – Employees may be motivated to work harder when they know that they will be personally benefitting from the rewards achieved.
- Increased loyalty – Employees are likely to be more invested in the success of the business, such that staff turnover should reduce significantly as a result.
- Increased engagement – Many EOT structures incorporate an Employee Council, which empowers staff to have a voice within the business, and ensures that everyone remains focused on achieving common goals.
What are the advantages of transitioning to EOT ownership for the selling shareholders?
The decision to sell the business is never an easy one for an owner manager, and the process itself can often be a stressful time in their lives for a variety of reasons. That said, a sale to an EOT should be less stressful for the following reasons:
- Tax free disposal – Subject to meeting the relevant qualifying conditions, the selling shareholders should not be required to pay tax on any money received from selling their shares to an EOT.
- Simplified sale process – Unlike a sale to an independent third party buyer, there will typically be only a minimal amount of due diligence undertaken on the company, and the legal process will be streamlined to remove any drawn out commercial negotiations.
- Ongoing involvement – Whilst the shareholders may have sold their shares to the EOT, they can remain within their existing leadership positions, providing them with additional comfort around the future payments of any deferred consideration sums.
Do I need to relinquish control of my business?
In short yes, as the EOT will need to acquire a controlling interest in the company in order to qualify for the relevant tax benefits associated with transitioning to the structure.
However, as referenced above, it is possible for the selling shareholders to retain leadership positions on the company’s board, which should help with business continuity in the short term. In certain circumstances, it is also possible (under the current rules) for them to be appointed as trustees of the EOT.
Can I sell my shares to the EOT at any value I choose?
The transaction must take place on an arm’s length basis, so we would always recommend that you have your business valued by a specialist before the consideration value is finalised.
Whilst it is possible for the shareholders to sell to the EOT for a price that is less than market value, they must not sell for any amount which is considered to exceed this value. In such a scenario, the excess will be treated as employment income, with income tax and national insurance levied accordingly.
Do all employees need to benefit from an EOT on the same terms?
Not necessarily, the rules do allow for benefits to be varied between employees, but this must be based solely on their levels of remuneration, length of service or number of hours worked.
In addition, it is possible to top up senior employees with Enterprise Management Incentive (“EMI”) options, which should allow them to acquire direct equity stakes in the business in the future. This will of course allow dividends to be paid on these holdings, as well as enabling the senior employees to receive cash proceeds from any future sale of their shares.
Can the EOT trustees sell the company in the future?
Whilst there is nothing preventing EOT trustees from selling the company, the tax position on such a transaction is likely to be discouraging. The selling shareholders should not pay any capital gains tax (“CGT”) on their disposal to the EOT, however, these liabilities are essentially deferred until a future sale by the trustees, at which point they will become payable to HMRC.
Additionally, any consideration received by the trustees from a future sale will ultimately be distributed to the employees, and these amounts will be treated as employment income, with income tax and national insurance deductions being applied accordingly.
If I do not sell all my shares, can the trustees prevent me selling the remainder in the future?
In theory there is a distinct possibility that they can, but only where it is in the best interests of the employees to do so. That said, this is generally managed using a put option, compelling the EOT trustees to buy the remaining shares at a future date for a consideration value based upon a predetermined formula.
It should be noted that any future disposal will be taxed to CGT in the usual way, with no further holdover relief being available to the shareholders.
Can I receive loan notes instead of deferred consideration on the sale?
Whilst loan notes can be used as part of the consideration structure, I have to ask myself why a selling shareholder would want to use these, when there is unlikely to be any tax benefit associated with doing so.
It is also not possible for the selling shareholders to take any security over the loan notes, as the EOT qualifying conditions do not permit this.
EOTs are becoming an increasingly popular succession planning option for companies in the current climate. Speak to one of our tax experts today and read about our most recent EOT deal to see how we can help you with the transition of your business.
