From Shopfloor to Topfloor - Is an EOT the Right Model for you?

From Shopfloor to Topfloor – Is an Employee Ownership Trust the Right Model for Handing Over Your Business?

Employee Ownership Trusts (EOTs) are becoming a popular way of allowing staff who have contributed to the success of a business to take over its ownership. But what are the advantages and risks of this form of transaction over more traditional sale processes?

What is an Employee Ownership Trust?

An EOT is a type of employee benefit trust introduced by the Government in 2014 to encourage more shareholders to set up a corporate structure similar to the “John Lewis” model of employee ownership.

With this legislation has come very generous tax breaks for existing owners which encourage them to move to an employee-ownership model. While not a good fit for every business, this has led to a rise in the use of EOTs by companies such as Richer Sounds and Aardman Animation, the studio behind Wallace and Gromit.

However, in order to qualify for these tax incentives, the employee ownership needs to be structured in a particular way. Broadly, the shareholders of a business must sell shares representing at least a majority stake (51%) to a newly formed trust – the EOT – which will then hold the shares for the long-term benefit of the employees as a whole.

Why consider Employee Ownership?

The structure is typically used to create an exit for a majority shareholder who does not want to sell to an external party and would instead like to reward existing management by allowing them to indirectly own the business that they have helped to build.

Common situations where EOTs are considered include:

• Succession - Family-owned companies where the next generation are not in a position to take over running the business.
• Retirement - Entrepreneurs who want to retire and realise value, but who want the business they have built up to continue with minimal interruption and don’t want to end their career working for a new buyer.

What are the advantages of an Employee Ownership Trust to shareholders?

There are a number of advantages for shareholders in selling to an EOT:

• No capital gains, income or inheritance tax liabilities should arise on the disposal of a controlling interest in a company to an EOT (or on the subsequent receipt of the purchase price by the former shareholders).
• Shareholders can still sell their shares for full market value, as they would look to do in a transaction with third parties.
• Not all shareholders are required to sell their shares to the EOT.
• Any directors with a minority shareholding can remain in post following the transaction and can continue to receive competitive remuneration packages.

What are the ongoing advantages for the company and employees?

It can be a ‘win-win’ because research has shown that employees with a stake in their business can provide significant benefits to the company including:

• Improvements to the performance of the business;
• Increase in productivity levels because employees have a vested interest in ensuring the success of the company;
• Improvements in staff retention – employees have a longer-term focus on the company’s future performance; and
• Aiding recruitment by adding extra dimensions to remuneration packages.

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.

How do the transacting parties arrive at the price?

Although on the face of it, the sale of shares to the EOT is a deal at arm’s length between the EOT and the shareholders, given the parties are somewhat connected, it is important for the trustees to be able to demonstrate to interested stakeholders that the EOT is not paying too much for the shares.

The trustees (who are in most cases already involved in or known to the company to some extent) are obliged to act in the best interests of the beneficiaries of the EOT. This can be achieved by being able to demonstrate the EOT is buying the shares at a fair price including getting a view on valuation from an independent party.

If the EOT is funded by way of gift or loan from the company in question, the directors should also be able to demonstrate that the company has entered these commitments in the best interests of the company and its shareholders. Overestimating the value in these cases unnecessarily introduces risk into the structure.

It is also important to consider whether any tax charge could arise for minority sellers who are employees by disposing of shares for more than their market value.

As there is no mechanism to agree a valuation for these purposes with HMRC prior to the sale of the shares to the EOT, all parties involved may wish to seek independent valuation advice along with the necessary corporate finance, tax and legal advice.

If you would like to explore whether an EOT may suit your business, please get in touch with our experienced team of experts.

Notes to editors
Smith & Williamson is a leading financial and professional services firm providing a comprehensive range of investment management, tax, financial advisory and accountancy services to private clients and their business interests. The firm’s c1,800 people operate from a network of 11 offices: London, Belfast, Birmingham, Bristol, Dublin (City and Sandyford), Glasgow, Guildford, Jersey, Salisbury and Southampton. Smith & Williamson is part of The Tilney Smith & Williamson Group.

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DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.