Employee ownership trusts can be a great way to incentivise your company’s employees and as an exit and succession strategy for business owners.

An Employee Ownership Trust (EOT) is a tax incentivised scheme that transfers control of a business for the benefit of employees. They can be used to motivate and retain staff as well as providing an exit or partial exit solution for shareholders.

In this blog, I will explain the key aspects of an employee ownership trust, including its benefits to both shareholders and employees, its uses and setting up an EOT.

What is an Employee Ownership Trust (EOT)?

Employee ownership is used to allow the share capital of a business to be partly or entirely owned by its workforce. An EOT acquires a controlling interest in a company from current shareholders. Employees don’t directly own the shares, but the shares held by the trust are used to the benefit of employees.

What are the benefits of an Employee Ownership Trust?

Employee ownership trusts can offer a multitude of benefits for both shareholders and employees including:

• Improve employee engagement.
• Improved business performance as employees are more engaged.
• Reduction in staff turnover.
• Availability of share capital to incentivise management and key employees.
• Alignment of the goals of stakeholders and employees.
• Provides an exit where there is no obvious trade purchaser.
• Faster implementation compared to a trade sale as no other parties involved.
• Enabling the business owner to retain up to 49% of the shares and some involvement in the business.
• Allows a tax-free disposal by UK individual shareholders.
• Can be more tax efficient than selling a business via a trade sale.
• Help to protect business continuity and the legacy of your business.
• Protects a business from take-over. 

Tax advantages for setting up an employee ownership trust

There are tax benefits for shareholders and employees as part of an EOT. These tax advantages are as follows:

Shareholders:

Fully exempt from Capital Gains Tax (CGT)

You will be exempt from Capital Gains Tax when you sell your controlling interest to an EOT. This means that no CGT is payable on the proceeds of the sale for the shares sold to the EOT in the year that the EOT is implemented.

Employees:

Income tax free bonuses for employees

All qualifying employees can benefit from tax-free annual bonuses of up to £3,600.

What are the different types of employee ownership?

There are different types of employee ownership options, giving businesses of all sizes and industry sectors flexibility and scope to benefit from employee ownership.

Direct employee ownership

Direct employee ownership allows direct ownership of shares in the business by employees. Employees might purchase shares or be gifted shares under a Share Incentive Plan (SIP), potentially tax-free. If tied to things like business growth targets, this type of model can improve employee retention and performance.

Indirect employee ownership

Indirect employee ownership is different in that the employees do not own shares in the company directly. In this model employees are beneficiaries of the trust which owns the controlling shareholding. Often this type of EOT model works better for businesses with higher staff turnover and those with more employees.

Hybrid model

This method is a combination of trust ownership and employee direct share ownership. The business owner sells their shares to the EOT when it is first established and then over time some of this interest is transferred to employees. This can be a good model for succession planning and to retain key employees when tied to performance metrics.

Why would I offer an employee ownership trust?

There can be many reasons for business owners to consider an employee ownership structure. For many owners it is a way to exit their business or partially exit and retain some control of the business.

When set up correctly, employee ownership can be a highly effective succession and exit strategy for sellers; in relation to return to the shareholders, creating continuity and retaining motivated, rewarded and engaged employees.

Shareholders can also implement an EOT to aid future growth and protect their legacy. An EOT will help to retain and motivate the employees, can help protect culture and values and aid business growth.

Tax savings can be available to both the shareholders and employees and this can also be an incentive to take this route.

Disadvantages of an Employee Ownership Trust

As with many things in business, as well as many benefits, Employee Ownership Trusts have some areas that should be considered before you set up. These are as follows:

1. If want to realise value from your business from Day 1 of a deal, then it’s worth considering that cash on Day 1 may be restricted by cash and reserves on the balance sheet, and funds that can be raised from funders by the EOT. Often with employee ownership, deferred consideration (where the EOT is funded by future profits) makes up the remainder of the consideration and is paid over several years.
2. The price for your business could be lower than that offered by an external strategic trade buyer. However, the price you get from a trade buyer may be more uncertain as this will depend on market conditions, finding the right buyer, findings during the due diligence process and other factors during the sale process.
3. Without the right management team that can take over the business an EOT may not be a viable option. Without the right people to take the company forward, the business may not succeed longer term. You need to assess if your team are skilled enough to run the business over the longer term and when you fully exit in the future.

Qualifying conditions for an employee ownership trust

There are a number of qualifying conditions that will need to be met before you set up an Employee Ownership Trust, these are:

1. The group or company must be trading.
2. The trust assets must be available for the benefit of all eligible employees on the same terms. Those employees with less than 12 months service can be excluded.
3. The assets of the trust can be applied based on remuneration, length of service and hours worked, with each of those factors to be applied separately. The assets of the trust cannot be applied such that only some employee’s benefit.
4. In order for the CGT relief to apply the Trustees must acquire a controlling interest in the company.

Running your company with an EOT in place

Undertaking a sale via an EOT does not mean that you transfer full control of the business wholly to the employees. The owner and other shareholders can remain involved at management level. However, you will be conceding board control of the business to a trust.

Employee ownership trust set up process

Typically, the process for setting up an EOT is as follows:

1. A purchase price will be agreed based on an independent assessment. This price must not be more than market value and payment will then be made in instalments.
2. A new company is created which will act as the employee share ownership trust and the shareholders sell their trading business shares to this EOT company.
3. A share purchase agreement is executed and after the sale, the company trades as a wholly-owned subsidiary of the EOT company.
4. A trust document sets out the obligations of the Trust to the employees.

Note, that funding will be required on set up of an Employee Ownership Trust so the EOT can purchase shares from the existing owners. The owners/shareholders are often paid for their shares out of future profits generated by the company, rather than the trustees being funded by third party lenders.

Who can be a trustee of an EOT?

When an EOT is created, many responsibilities for the future success of the trust fall to the Trustees. The Board of Trustees can be made up of Employee Trustees, Professional/ Corporate Trustees, and often one of the sellers will take a Trustee position too. The Board can have multiple Trustees per representative group.

How do EOTs work for your employees?

You are not legally obligated to involve employees in the company sale to an EOT. However, it is important to communicate the basis of the EOT and the benefits to them as employees. Your employees should understand the following:

• Individual employees are not issued separate share certificates with their name on.
• Each employee does not personally own a percentage of the business; they are working for the collaborative benefit of the trust and company and not just for their personal benefit.
• They may benefit from income tax free bonuses of up to £3,600 per year (this is still subject to national insurance).

Profit distribution

There are a variety of ways of using the profit generated. This will be decided by the Trustees and the options are as follows:

• Company profit can be distributed via the EOT to employees. The profit share can be distributed as an equal sum for all or can be allocated in relation to an employee’s remuneration, length of service or pro-rated for hours worked. You can also have different profit ‘pots’ that can then allocate the profit within different rules.
• In many cases, this future profit can be used to pay the owner for the shares as deferred consideration.
• Profits are used as working capital for the business.
• The profits are retained for future investment opportunities for the business.

Conclusion

Employee ownership is growing in popularity as its appeal is both as a succession planning strategy and a growth strategy by business owners.

As a succession planning tool, an EOT can provide owners with an easier way to exit a business and realise value, whilst retaining some controlling interest and protecting their legacy.

Setting up an EOT can be simpler to undertake than a trade sale, with no requirement for a third-party buyer to be involved. The company valuation is a commercial discussion with no requirement for the involvement of a third party to agree a sale price.

As a growth strategy, it can help retain and motivate employees as well as protecting culture and values when the shareholders eventually exit the business.

There are clear tax benefits also of an EOT for both shareholders and employees. These savings can be in Capital Gains Tax, Inheritance Tax and Income Tax.

However, the rules can be complex with various qualifying conditions, so it is important that professional advice is sought when considering and setting up an EOT.

How Barnes Roffe can help

We have implemented EOTs for our clients in a wide variety of sectors and with a wide range of objectives. We will:

• Understand both the shareholders and business objectives.
• Review various options regarding future structure and employee share options.
• Review the qualifying status of your business for an EOT.
• Conduct valuations.
• Deal with HMRC on your behalf.
• Create the company for the EOT.
• All documentation required.
• Liaise with legal advisors on setting up the correct legal structure.

For more help and advice on Employee Ownership Trusts and other employee share options, contact us.

Related articles

Can sustainable businesses still be highly profitable?

Succession planning – what business owners can learn from the Royal family

Why do companies reorganise?