Employee Ownership Trusts

Published: 21 September

A lull in business sales during the COVID-19 pandemic and anticipated rises in UK Capital Gains Tax has resulted in a large increase in the number of business owners selling their businesses.

There are several options available including:

1. A ‘Trade Sale’ to someone in your or in an associated industry.
2. A management buy-out (“MBO”), which is a sale to your management team (or indeed an external management team – “MBI”).
3. Private Equity, with funds brought into the company and a director or two, seeking to grow the company quickly and then exit again.

Or indeed as per the title of this Article, using an Employee Ownership Trust. An “EOT”.

EOTs have been around since September 2014 and have not really caught on as much as the government had hoped, largely because of the requirement that employees must always hold more than 50% of the company. That lack of control has put business owners off the idea of an EOT.

During the pandemic, the use of EOTs shot up, as there are a number of benefits compared to a traditional trade sale, including:

• Speed and ease: Employees and Shareholders are usually able to conclude a quick amicable deal without complex sale negotiations. This in turn means that professional fees can be a lot lower.
• UK shareholders get 100% CGT exemption (there are no Income or Inheritance Tax consequences either).
• The shares can be sold at full market value.
• The outgoing shareholder can remain as an employee and director earning appropriate market rate remuneration.
• It allows for flexibility, as not all shareholders have to exit.

There is a whole raft of other benefits as well (See later). But before we go on, what is an EOT?

What is an EOT and how does it work?

An EOT is a form of employee benefit trust created to allow wider employee ownership of shares – Think John Lewis, (but perhaps not about the losses they made in 2020!)

Shares are held in a trust for the benefit of the employees, and importantly the trust must own more than 50%. The trust is for the benefit of all employees, all on the ‘same terms’. The shares are held by the trust though and are not allocated to individuals. ‘Same terms’ does though allow variation by employees according to length of service, remuneration or hours worked, so there is flexibility.

The first step it to form a new company, to be the corporate trustee of the EOT. (“Trustee Company”)

Secondly shares in the trading company are then sold to the Trustee Company. The trading company is valued independently for the shareholders and the Trustee Company. Under a share purchase agreement, the shares are transferred to the Trustee Company at the agreed price, in return for a loan owed to the trading company.

Finally, the loan gets repaid by contributions from the trading company to the Trustee Company, from profits, which are used to pay the original shareholder. 

Other benefits

I mentioned earlier that there are lots of benefits. The ones I mentioned earlier were all for the outgoing shareholders.

• Employee engagement is the real driver. Shareholding employees are more committed, more passionate about the company, and exhibit less absence from work.
• As a result, the business is likely to more profitable.
• Typically, employees would not have sufficient personal funds to acquire – this allows succession to happen without the funds being available personally.
• Bonuses: Companies controlled by EOTs are also able to pay tax-free cash bonuses to their employees of up to £3,600 per employee per year.

Meeting the conditions

So, if that all sounds good, what conditions do I need to meet? There are five and they are as follows: -

1. The company whose shares are transferred must be a trading company or the principal company of a trading group.
2. The trustees of the EOT must restrict the application of any settled property (the shares) for the benefit of all eligible employees on the “same terms”… but as mentioned earlier, “same terms” gives flexibility as per point 5 below.
3. The trustees must retain, on an ongoing basis, at least a 51% controlling interest in the company.
4. The number of continuing shareholders (and any other 5% participators) who are directors or employees (and any persons connected with such employees or directors) must not exceed 40% of the total number of employees of the company or group.
5. Trust property must generally be applied for the benefit of all eligible employees on the same terms, but the trustees may distinguish between employees on the basis of remuneration, length of service and hours worked.

More flexibility needed?

You may wish that, perhaps and for example, other senior employees should have additional shareholding above their indirect share through the EOT. This could be achieved by Employee Incentive Share Option schemes. (“EMI” options).

They would be allowed to subscribe for additional new shares in the company on hitting certain targets. The targets can be widely written and different for each person. They will acquire the shares at the current market value at the date of granting the option (rather than the value at the exercise of the option). The amount they pay will be a significant discount against the full market value, since they would be acquiring a minority shareholding, thus allowing you to justify a lower value.

Finally remember that whilst control goes by having less than 50% of the shares, there will be shareholder agreements in place.

What next?

This article can only serve as an introduction, as with all tax and succession planning there will be quirks and nuances for personal circumstances, as well a wider tax legislation to comply with.

For more information on EOTs or any form of employee share ownership, please contact us. Email Adrian directly: adrian.barker@cbslgroup.com