Employee Ownership Trusts (EOTs) have gained popularity recently as a business ownership model, offering a unique approach to fostering a sense of shared responsibility and engagement amongst employees. It is also a tax efficient way for the owner of a business to exit and take advantage of 100% tax relief.

But what is an EOT and what are the advantages and disadvantages of utilising it when you exit your business?

Employee Ownership Trusts: Introduction & The Rules

Employee Ownership Trusts (EOTs) were introduced in the Finance Act 2014 by the UK Government as a way to structure a business that allows employees to (collectively) to have a controlling interest in that business. The shares of the company are held in a trust on behalf of the employees who are eligible for income tax free bonuses as employees of an EOT-owned company.

Employees are also eligible to share in the net transaction proceeds if the business is ever sold in the future.

How Can An Employee Ownership Trust Be Used?

An EOT can be used by businesses for a variety of reasons:

➡️If a business owner is thinking about selling their business in order to generate capital

➡️If the owner is looking to retire and wants to sell their business to their employees

➡️To re-structure the business in a more tax efficient way

The UK Government supports this business model by allowing the sellers of the shares to sell with full Capital Gains Tax (CGT) relief on the sale proceeds. Employees under an EOT structure do not take direct ownership of any shares, but are beneficiaries of a trust

Eligibility Criteria

➡️To establish an EOT, a company must be a trading company or the holding company of a trading group

➡️The majority of the company’s employees must be eligible to benefit from the trust

Sale of Controlling Stake

The trust is typically funded by the company itself through the sale of a controlling stake to the trust. This transaction must be at a fair market value, and the trust usually borrows money to finance the purchase. It is advisable that an independent business valuation is undertaken at the start of the process so that there is absolute clarity between all the parties involved.

How is the sale of a business to an EOT funded?

✴️Free cash on the Balance Sheet

✴️With a loan from the outgoing business owner – the EOT trustees borrows money from the  

      seller with a company guarantee. The loan is repaid over an agreed period of time

✴️With a loan from the bank – A sum of money is borrowed from the bank and the trustees

      repay this to the bank over time

What Happens to the Business Owner After Selling to an EOT?

There is actually no requirement for the owners of a business to step down following the sale of their shares to an EOT. Indeed, many continue to run the company from an operating perspective for a reasonable time after the sale is completed.

This results in management continuity and it increases the chances that the company remains successful too – it also enables the seller to monitor and manage business performance which increases the chances that the deferred consideration that will be part of any transaction will be paid as agreed.

Advantages of Employee Ownership Trusts

✅Employee Engagement: When employees have a stake in the company’s success, they are often more motivated, leading to increased productivity and a stronger commitment to organisational goals.

✅Succession Planning: EOTs provide a viable succession planning strategy, especially for business owners looking to exit while ensuring the continuity of the company. It allows for a gradual transition of ownership rather than a sudden change resulting from a third party acquiring the business

✅Time to Set Up An EOT: This is generally less than third-party sale alternatives and can be as little as 8-12 weeks (compared to 9-12 months for a third party sale)

✅Transaction Costs: The costs of setting up an EOT and then initiating the share sale are often much lower

✅Fair Market Value: Sellers of the business sell their shares at fair market value with a greater certainty of completion, as they control the major aspects of the transaction

✅Staff Retention: An EOT provides a competitive advantage in the respect that it leads to greater retention of staff and can be attractive to new staff coming into the business

✅BADR Unaffected: At the present time sale proceeds do not reduce Business Asset Disposal Relief (the current limit for which is £1 million)

✅Future Sale Proceeds: If the company is sold at some point in the future, qualifying employees will share in the sale proceeds

Disadvantages of Employee Ownership Trusts

❌Lack of Direct Control: Employees, as beneficial owners, do not have direct control over the shares held in the trust. This can lead to a sense of detachment or frustration among some employees who may desire more involvement in decision-making processes.

❌Financing Challenges: The initial financing of an EOT often involves borrowing, and this debt can be a burden on the company. Managing the repayment of the loan while ensuring the ongoing success of the business requires careful financial planning.

❌Complexity and Costs: Establishing and managing an EOT can be complex, involving legal and administrative processes. Additionally, there are costs associated with setting up and maintaining the trust structure.

Conclusion

For anyone in the UK who is looking to sell their business and who meets the qualifying criteria then an EOT can be a tax efficient way to exit. There are numerous advantages as discussed above including the retaining staff and promotion of business continuity.

The above is intended to provide an overview and further advice should be sought before committing to the process. If you would like to know more then send me a message.