Employee Ownership Trusts – a route to an exit?
With capital gains tax constantly in the news amidst rumours of an increase in the future and with the benefits of Business Asset Disposal Relief already reduced, many company owners might be anxious about exiting without losing a significant amount in tax.
Perhaps one solution would be to sell some or all of your shareholding to an Employee Ownership Trust (“EOT”). With careful planning, you can ensure the future of your company and its employees as well as benefiting from paying no capital gains tax.
What is an Employee Ownership Trust?
EOTs are an excellent way for business owners who are looking to step back from their business. The shareholders of a company can sell their shares to a qualifying EOT, and thanks to the exemption will pay no Capital Gains Tax on any gain that they have made on the value of the shares. In the past, owners would have the options of selling to a competitor or selling to the highest bidder. Both come with drawbacks as by handing over control to a third party, you risk seeing your company restricted with a potential change of employees, change of products, and change of the management style.
One solution to this is to change over the company to employee owned, one notable example of this is the corporate structure used by John Lewis, who are the largest employee-owned business in the UK. HMRC states that Employee ownership is where all employees have a ‘significant and meaningful’ stake in a business.
This means employees must have both: a financial stake in the business (e.g., by owning shares), and a say in how it is run, known as ‘employee engagement’.
What are the rules?
- The shareholders must sell at least 50.1% of the company’s share capital to the EOT.
- The shares must be ordinary shares with the majority of voting rights.
- The business must be a trading company.
- There must be a commercial reason for wanting to use an EOT, which will benefit to both the company and the employees.
- The All-employee Benefit Requirement – any benefit to employees must be on the same terms for all eligible employees.
- However, it can give benefits of various amounts to employees based on factors such as remuneration, hours worked and length of service.
What are the benefits of EOTs?
Employee ownership trusts have many incentives to offer both the seller and the employees:
- Attractive tax reliefs including:
- zero Capital Gains Tax
- up to £3,600 income-tax-free bonuses per annum.
- The existing management team can stay in place after the sales.
- Staff jobs are secure and a greater staff retention.
- A lot less stressful – no need for negotiations going back and forth between parties.
- The sale is usually a lot quicker than selling to a third party.
- Less expensive than selling to a third party as the owner can still be involved and have a role within the company. e.g., they may choose to stay on the board even after the company is sold.
- Employees are motivated to work harder and are driven to help the business succeed.
- EOTs show a decrease in sickness and absenteeism in employees.
- Business productivity improves thanks to the continuity of management.
What are the disadvantages?
There are very few disadvantages to this scheme, which is why it is such a great option for those looking to sell their business.
Sellers must be aware of the following when deciding whether to choose an EOT structure:
- The owners selling the business will be paid over a period of time, instead of receiving the cash straight away.
- Payment for the shares is usually done from future profits, therefore if there are any concerns that the company will not make future profits, then funding the sale of the company will be difficult.
- If the company ceases trading in the future, the condition of being a trading company is breached and the owners will be liable to Capital Gains Tax for the sale.
- As the trust is controlled by the trustees who have the majority of voting rights, the seller must choose these individuals whose vision aligns with theirs.
So how does it work?
The main steps of setting up an EOT are:
- The target company will establish a qualifying EOT with either a corporate trustee or multiple trustees with an independent trustee and am employee representative.
- A purchase price will be determined using an independent valuation.
- The sellers and the EOT will agree the consideration for the sale – usually an initial lump sum with the rest being paid overtime.
- The trading company will use future profits to make contributions to the trust, and the trust will in turn use this to pay the remainder for the purchase price.
If you are a business owner thinking of selling your company, the possibility of using an EOT might be a good fit. EOTs are extremely beneficial and therefore come with a raft of complex rules which with right professional advice can be navigated to get the right structure for you. Having completed on multiple sales to EOTs we have an experienced team here to help.