Business Exit Strategies: Employee Ownership Trusts (EOTs)

One of the most obvious benefits of adopting an EOT ownership model is that it can be a platform for creating or building on an employee-focused culture, resulting in increased levels of employee engagement and incentivisation.

But the benefits do not end there. Increasingly company owners who wish to retire/exit their businesses and who have been unable to find a suitable third-party buyer, are turning to EOT ownership models as a method of succession planning. Not only does an employee “buy-out” facilitate the desired exit for the company owners, but it can also have substantial tax advantages if structured correctly, in the form of an exemption from any capital gains tax.

The following article from Nick Davies, Corporate Partner at Steele Raymond and Tax Consultant Dr. Philippa Roles, discuss EOTs and summarise what is needed for an effective EOT and how an EOT can be used as an effective business exit strategy.

What is an EOT?

An EOT is a type of discretionary trust, which basically means that there are trustees who hold the legal title to the trust assets (in this case, company shares) for the benefit of a defined group of beneficiaries. NO single beneficiary has an identified interest in the trust, but rather the hope/potential to receive something from the discretionary trust at a future date.

Using a discretionary trust that holds the company shares for the benefit of employees is a relatively simple way for a company to become employee owned and is far simpler to manage than allocating all the shares to employees individually.

Where an EOT is going to be used to acquire company shares, typically that EOT will acquire a majority shareholding (i.e. more than 50% of a company). It is actually a requirement that an EOT becomes the majority shareholder if the tax advantages described below are to be obtained.

What are the tax benefits of an EOT?

In order to encourage more employee-owned companies, the UK government in 2014 brought in tax legislation that exempted from capital gains tax (CGT) certain disposals of shares made to an EOT . This offered a potentially valuable tax break to exiting owners of companies.

In addition to the tax breaks given to owners, a limited relief from income tax on bonuses (up to £3,600 per year per individual paid by an employer company owned by an EOT) was also introduced; along with relief from Inheritance Tax on certain transfers into and from EOTs.

To obtain these tax advantages, an EOT must:

• Contain a controlling interest in the company i.e. greater than 50%
• Be established for the benefit of all employees (excluding, broadly, individuals who hold or have previously held 5% of the shares) in the company
• Treat all employees on an equitable basis

How to set up an EOT

There are various legal procedures and transactions involved in setting up an EOT, but the basic process involves:

1. The current shareholders (the sellers) must sell anything from 51-100% of the business’s total shares to the EOT. The sellers will usually pay no CGT on the shares sold in the year the EOT acquires more than 50% of the shares
2. The EOT pays for the shares with proceeds from third party financing and/or with a loan from the sellers.
3. The sellers will usually receive payments in instalments and third party financing will be repaid through the contributions from the company.
4. As an incentive to align interests, the company may issue shares or warrants/options to key managers and employees.
5. Employees will then be eligible to receive income tax-free bonus payments up to £3,600 per employee per annum.

Practical benefits of an EOT as a business exit strategy

Getting a guaranteed sale price

Normally, there is no way to know for sure exactly how much you will be able to sell your business for until you place it on the market and see what buyers are willing to pay. However, with an employee ownership sale, the price will be set at a fair market value, so the owners will quickly know exactly how much they will receive from the sale, providing certainty.

Making a business sale tax-efficient

As mentioned above, as long as the right conditions are met, transferring a business into an EOT can allow the sellers to be exempt from CGT. Employee ownership therefore enables outgoing shareholders to see a significantly larger after-tax profit on the sale of the business.

Retaining the outgoing owners’ experience and expertise

The selling owners will often retain a percentage of the ownership of the business and take a reduced role, rather than leaving the business entirely. This can help facilitate a stable transition while keeping the previous owners’ experience available to the business.

Boosting employee engagement

Making employees co-owners of the company gives them a real stake in the business (“skin in the game”). This can significantly improve employees’ relationship with the business, leading to greater employee engagement, productivity and loyalty.

Keeping your company independent

When business owners exit, it is not unusual to see the company being sold to another company, so becoming part of a larger group. Employee ownership can allow your business to survive and thrive as an independent entity.

Who are the trustees of the EOT?

A trust does not have any legal personality on its own so it must operate through either individual trustees or a single corporate trustee. It is common for an EOT to be established using a single corporate trustee (often a company limited by guarantee).

This trustee (or trustees) will hold the legal title to the assets that are held in the trust (i.e. the company shares in this case), but the beneficial ownership of the assets in the trust belong to the beneficiaries of the trust (the employees) as a whole; with no one individual employee having an identifiable interest in a particular proportion of the assets.

The EOT trustee’s role is not to manage the company on a day to day basis (this role remains with the directors of the company), but to make sure that the company is being led competently and in a way that ensures employee commitment and engagement.

The beneficiaries of the EOT (the employees) need to have a say in the way the business is run (particularly so if the company wants to ensure full employee engagement/buy in). This is usually practically managed by using an employees’ council, having employee directors on the board and having a company constitution to define values in relation to employees.

Make an Enquiry

If you have any questions regarding your business, a business exit, a merger or any other corporate legal query, please contact Nick Davies on 01202 294566 or email [email protected]