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Employee Ownership Trusts – a win-win path to succession
Robin Hastings
The utilisation of Employee Ownership Trusts (EOTs) as a way of exiting a business has grown massively in recent times. This is partly due to the considerable tax benefits it can propose for a selling shareholder, but also because of the long-term advantages it can create for the business subject to the sale.
This article summarises EOTs typical structures and highlights some of its key advantages– for both the selling shareholders and the company being sold.
What is an Employee Ownership Trust (EOT)?
An EOT is a trust vehicle which is established as a trust for the benefit of a trading company’s employees. This involves incorporating a company (generally limited by guarantee) to act as the corporate trustee and putting a trust in place between the trustee and the trading company, providing that the assets of the trust are to be held for the benefit of the employees of the business.
The trust would then purchase a majority shareholding in the company, and the shares would form part of the trust assets. The company’s employees would therefore not be shareholders, as such, but rather have an indirect interest in the ownership of the company. The directors of the EOT itself would usually comprise a mix of the directors of the trading company, a director elected on behalf of the employees (thereby giving the employees a voice at board level), and an independent trustee director.
What are the Tax Advantages and Benefits of an EOT?
The disposal itself would generally be free of capital gains tax, income tax and inheritance tax – which is one of the main advantages for the exiting shareholder. However, due to the increased involvement of the employees (perhaps through including an “employees’ council” as part of the trust’s constitution) the EOT carries considerable opportunities for attracting, keeping and incentivising employees, who may feel more involved in the dealings of the company as a result of the indirect ownership it creates, as well as giving the ability to declare tax-free bonuses (up to £3,600 per year per employee). Therefore, employee-owned companies may see significant benefits relating to profitability, staff retention and productivity, and decreased absenteeism issues (and, potentially, the ability to offer more competitive remuneration packages).
How to qualify for an EOT
As well as being a trading company (so not, for example, an investment company), there are several requirements which the company must meet in order to qualify for the tax benefits:
- Firstly, the EOT must acquire a majority of the company’s shares (and also of its voting, capital and income rights) (the “controlling interest” requirement).
- Secondly, the terms of the trust must not permit the trust property to be applied other than for the benefit of all of the company’s eligible employees (the “all-employee benefit” requirement).
- And thirdly, any distribution or payment from the trust, for example, any bonus payments, must be for the benefit of all employees, on the same terms (the “equality” requirement).
As the eligibility requirements are so strict, we recommend that you firstly contact your accounting, tax and legal advisers, who will be able to ensure that the transaction is structured properly and that the key documents (particularly the trust deed, constitutional documents and share purchase documentation) are all drafted within the legislative parameters. Your professional advisers will also ensure that the company can actually qualify and will ensure that the parties can take advantage of the favourable tax treatments.
How does an Employee Ownership Trust work?
As with any type of deal, there is no “standard” EOT transaction – however, the most common structure theme that we see is where the shareholders will sell a majority of the company’s shares (anything between 60% and 90%) and retain a small proportion (or leave some available to incentivise key management, perhaps through providing direct equity or via an employee share scheme like an enterprise management incentive (EMI) scheme). The purchase price for the shares sold would then usually be paid on a deferred basis, typically over two or three years, with the company funding the payments through cash flow contributions or gifts to the trust.
Bermans has acted for several banks and alternate lenders, who in recent years have become more receptive to providing secured funding for EOT structures. Therefore, as well as advising on the structuring and trust side an EOT, we also regularly advise lenders who are providing finance to the deal.
Interested to know more?
If you would like to discuss the potential of a sale to an EOT, or would be interested in exploring funding options further, please feel free to get in touch with us – we can discuss how the transactions can be structured in more detail and, where possible, introduce you to advisors who may be able to help you decide if the EOT model is something which could work for you, or if a more “traditional” exit route would be more suited.