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Exploring your exit options: Employee Ownership Trusts

Tuesday 21 January 2020

Growing a successful business can often be a lifetime’s work. But what happens when you’ve realised your growth ambitions? As part our Exploring Exits series, we are delving into the options available to business leaders wanting to plot out the best exit route for them, taking in companies of every size and sector.

In this article, we explore Employee Ownership Trusts as a route to exit and weighs up the associated benefits and drawbacks.

What is an Employee Ownership Trust?

Employee Ownership Trusts (EOTs) involve a business’ shareholders selling at least a majority interest – equivalent to 51 per cent – to a new trust (the EOT) which holds the shares for the benefit of all the employees in the business. The EOT might be a new company specifically established to act as trustee with directors appointed from the workforce and/or external independent appointments, or it could be an independent professional trustee entity.

What are the positives of an EOT?

EOT disposals are an increasingly popular form of shareholder exit, despite the EOT legislation having first been introduced back in 2014. This followed an increased focus on the John Lewis model of employee ownership, with independent research clearly highlighting employee ownership as being mutually beneficial for employees, businesses and the wider economy.

It isn’t entirely clear why EOTs are enjoying such a surge in popularity. The advantages of selling shareholders a capital gains tax-free disposal is obvious, but much has already been made of the fact that Entrepreneurs’ Relief already provides a very generous 10 per cent rate of capital gains tax in any event. Arguably, current EOT popularity is down to a combination of factors, including the availability of tax-free sale proceeds, the state of the wider market, the availability and profile of willing buyers and investors, and an increasing awareness of, and appreciation for, employee ownership as a concept.

Provided that the various qualifying conditions are satisfied, the main tax reliefs of EOTs are that the sale of shares to the EOT are free from capital gains tax and employees of the company can receive annual bonuses of up to £3,600 free from income tax.

EOT disposals are most likely to be on the agenda when controlling shareholders are reluctant to sell to a third-party buyer but would like to reward employees by allowing them to indirectly own the business. One example of this is the owner-managed business, where the owner wants to retire and realise value, but equally wants the business to continue without being under third party ownership, and without having to work for such a third party after the exit. Another is in family-owned businesses, where the next generation is not able to take over from the current owners.

It should be remembered that the EOT will be a unique type of buyer, often incorporated or established only very shortly before the transaction occurs. The funding will therefore need to be carefully considered as part of the wider transaction planning.

What are the negatives of an EOT?

EOT transactions are not entirely ‘tax-free’, however – stamp duty will be payable on the acquisition of the shares, and the tax-free annual bonuses still attract national insurance contributions (NICs).

In the next article in this series, corporate solicitor Rachel Brassey will look at share and asset sales.

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