The use of Employee Ownership Trusts (EOT) by business owners of private companies to achieve their exit plans has seen a considerable rise over the past five years, with 100 new employee-owned businesses registered since June 2020(1), and an expected continuation of growth throughout 2021 – but is this exit strategy right for you and your business?
To encourage a move to employee ownership, there are generous tax benefits available for owners who transfer their shares to an EOT – such a sale can be made without attracting any charge to capital gains tax. The tax relief on this type of exit strategy was introduced in 2014 to enable SMEs to capture the significant benefits of employee ownership that larger businesses had achieved. With advantages such as a more engaged and happier workforce, and ultimately a more profitable business (1), the benefits can be hard to ignore.
What are the criteria for the tax relief to apply?
The main criteria which must be met for the tax relief to apply are:
- the seller must be an individual or trust, not a company;
- the shares must be ordinary shares, not preference shares;
- the company must be a trading company, or the principal company of a trading group;
- the trust must acquire a controlling interest in the company (which it did not previously possess); and
- after the sale, at least 60% of employees must hold less than 5% of any class of share.
Additionally, the EOT which acquires the shares from the individual or trust must meet the following criteria:
- the trust must generally be for the benefit of all employees of the company/group, who must all benefit on the same terms (employees who have worked for the company/group for less than 12 months can initially be excluded), and the trust can permit funds to be applied for charitable purpose;
- the trust must exclude employees who, within the last 10 years, have owned 5% or more of the shares in the company (or of any class of shares in the company), or who, on a winding-up, would be entitled to 5% or more of the assets of the company, and anyone connected with such employees must likewise be excluded;
- the trust can allow employees’ entitlements to vary with their remuneration, length of service or hours worked, but all eligible employees must have some entitlement; and
- the trust cannot make loans to the employees.
Are there any other advantages to selling a company to an EOT?
- Tax advantages – in addition to no capital gains tax when selling a controlling interest (51%+) to an EOT, eligible employees can also be paid income tax-free bonuses of up £3,600 per year.
- An EOT is a readily available purchaser – selling to an EOT removes the need for the seller of the business to identify a buyer for their business. This could be useful where the seller has struggled to find a buyer or where a family business has succession issues where the next generation are unwilling to takeover.
- Succession planning – when selling a business, often one of the biggest concerns for business owners is ensuring their employees are well looked after post-sale. Selling to an EOT removes the requirement to ensure the potential buyer is a good ‘cultural fit’, whose values match those of the existing owners. The trustees can include the existing owners, therefore resulting in a seamless transition, with minimal disruption to the day to day running of the business.
- Price negotiations – With many business sales, a common ‘stumbling block’ is negotiation of price, which can sometimes cause fraught discussions. When selling to an EOT, the price is often determined by obtaining a professional valuation of the company. The trustees must ensure they are satisfied that they are not overpaying, but this process is usually a lot more straight forward than usual price negotiations during a business sale.
- Giving employees more involvement in the business increases motivation and engagement – EOTs are proven to improve productivity, reduce absenteeism and develop more engaged employees through inclusive, transparent, and effective models of corporate governances (2).
- Retaining and attracting staff – if the company is owned by an EOT, there is the possibility to introduce an employee share option scheme for sought after individuals, which could see retention rates and career progression enhanced, enabling the business to attract the most skilled and ambitious employees in their industry.
- Option for sellers to remain very involved in the business – When selling to an EOT, sellers generally retain a minority shareholding and remain as directors, typically receiving market rates of pay, provided the conditions described earlier are satisfied. Although this could also be the case in third party sales and management buy-outs (MBOs), the seller’s influence is likely to be less in these scenarios.
Get in touch
The significant advantages of a sale of an EOT could provide a welcome solution for anyone looking to exit a business as well as those who want to transfer ownership to the workforce for philanthropic reasons. However, this type of transaction can be challenging and certainly not a quick process. The corporate finance team at PM+M can talk you through all aspects of the process, including introductions to potential funders to finance the purchase and working closely with our in-house tax specialists to ensure all areas are covered. Get in touch at corporatefinance@pmm.co.uk.
