Employee Ownership Trusts

FAQs

• I want to retire — who will run my business after it’s sold?

  Selling your business to an employee ownership trust can provide you with greater flexibility to bring in a new leadership team in a more controlled manner.

  Equally, if you are keen to achieve a sale and crystallise capital value, then the fact that there is no management team ‘in waiting’ is not, in itself, a barrier to achieving that exit.

• Why use an employee ownership trust?

  A key succession challenge for many business owners is how to achieve an exit in a way that recognises the full market value of the business while enabling the business to retain its strong brand identity and cultural integrity.

  Employee ownership is becoming increasingly popular and forming part of many business owners’ retirement planning discussions. By selling to an employee ownership trust, owners can protect the independence of the business, safeguard and incentivise staff who have helped build that success and ensure that a strong legacy is retained.

  There are also a number of financial advantages — both to the business owner and employees — with no capital gains tax payable on the disposal and income tax exemptions on employee bonuses.

• How does an employee ownership trust work?

  The ownership of a majority shareholding is sold to the trustee of an employee ownership trust, which is established for the benefit of all the employees of the business.

  This is a form of indirect ownership, meaning that employees don’t hold shares in their own names. Rather, the shares are held in trust, such that a trustee holds the shares for the benefit of all employees in the business. 

  As the majority shareholder, the trustee has a responsibility to ensure that the business is supportive of a culture of employee ownership. However, the board of directors of the trading company retains responsibility for the day-to-day running of the business. The employees therefore become incentivised stakeholders but do not step into the shoes of the management board.

  As employees join the business, they automatically become beneficiaries of the trust. When they leave, they automatically cease to be beneficiaries.

• How are employee ownership trusts structured?

  When choosing employee ownership as part of your exit strategy, you can structure the deal in various ways. The trust only needs to hold a controlling interest for the tax benefits to apply.

  So while you may wish to dispose of 100% of the shares, you could instead opt for a partial exit by retaining up to 49% of the shares.

  This can be appropriate:

  • if the business cannot afford to support the purchase price for all the shares
  • where a retained minority stake may benefit from future dividends
  • where it is considered desirable to retain an element of family ownership, capable of being passed on to future generations.

  Alternatively, you may wish to consider a hybrid structure, which would enable you to reward management or senior employees by issuing shares directly or through the grant of EMI share options.

• What are the benefits of an employee ownership trust?

  Statistics have shown that employee-owned businesses deliver a more productive and inclusive economy by unlocking enhanced performance and productivity, providing a more sustainable and resilient business model and increasing employee engagement.

  The business owner will still achieve a market-value exit from the business, with no capital gains tax payable on the disposal. Unlike a trade sale, an employee ownership trust disposal avoids the need for extensive due diligence and protracted negotiations, which can provide for a relaxed sale process. The business owner can also protect the integrity and culture of the business and ensure that a strong legacy is retained.

  Employee-owned businesses have been proven to increase staff retention and incentivise them to drive success. By selling to an employee ownership trust, employees will also avoid any potential disruption that often comes with a trade sale and will not suffer from any adverse effects of integration to a trade buyer. They also have the benefit of tax-free bonus payments of up to £3,600 for each employee in any year.

  For employees, an employee ownership trust exit can avoid the upheaval of alternative exit routes such as a sale to a trade buyer, who may want to rationalise staff as part of an integration policy. Once employee-owned, a business is then in a position to pay bonuses to employees of up to £3,600 for each employee in any year, without paying income tax on that sum. As stakeholders, staff also show greater commitment and entrepreneurship in employee-owned businesses, which can lead to greater levels of individual wellbeing and greater overall productivity.

  Overall, employee ownership trusts are a fantastic way to achieve the succession of your business if you care about your staff and want to leave a strong and sustainable legacy. Just make sure that you don’t cut corners and get the right advisers on board to discuss your objectives early in the process.

• Is an EOT the right solution for your company?

  Employee ownership models are becoming increasingly popular for businesses of all shapes and sizes. They provide a whole host of benefits for businesses, business owners and employees.

  There are four key considerations to make when deciding whether an employee ownership trust disposal is right for your business:

  1. Succession

  While you might have already contemplated a trade sale or management buyout, if the concept of being acquired by a competitor or larger group is unappealing — and if your management team does not have the appetite or financial means to take control of the business — then employee ownership could be the right solution.

  2. Legacy and culture

  A trade sale might not be desirable if you have concerns that the business will be taken over by a trade buyer who could damage its legacy. One of the main reasons business owners are drawn to employee ownership is that it can preserve the culture of the business and can be a way to protect and enhance that culture for the long term.

  3. People

  Employee ownership is ideal for a business that is driven by its people and their productivity and that places high value on the engagement and well-being of their employees. Becoming employee-owned can build on the existing employee-focused culture and increase engagement.

  4. Profitability

  While disposal to an employee ownership trust is a viable way to achieve market value, the business needs to be financially robust and generate a certain level of profits to ensure the success of the transaction. However, there is the ability to structure the deal with some flexibility or raise external debt to help fund the purchase price.

• Will the employees control business decision-making?

  An employee ownership trust represents indirect (rather than direct) employee ownership. This means that employees don’t hold shares in their own name. Instead, the shares are held in trust such that a trustee holds the shares for the benefit of all employees in the business.

  As a majority shareholder, the trustee has a responsibility to ensure that the business is being run in a way that is compatible with employee ownership. However, the board of directors of the trading company will retain responsibility for the day-to-day management of the business.

• How will my business be valued?

  The market value of a business is ascertained by an independent expert valuation. The ultimate purchase price paid by the trustee should reflect that valuation (though it is possible for the selling shareholders to sell at a discount to market value, if that is desirable).

• How can I fund an employee ownership trust?

  Funding the sale can provide you with an element of flexibility, as you are able to determine how and when you receive the consideration for your shares.

  The most common way to fund the sale is via cash in the company, with the majority deferred over a number of years. However, external funding is also possible and gaining popularity.

  If cashflow is tight, funding a sale to an employee ownership trust could be a challenge. A certain level of underlying profitability is key to achieving a successful transaction. That profitability is either needed to support vendor loans (so that part of the purchase price is paid to the sellers in instalments) or to service any financing arrangements in support of funding the purchase price. 

  Furthermore, without distributable reserves, the business would not be in a position to contribute amounts to the trustee for payment by the trustee of the purchase price.

• Zero capital gains tax sounds too good to be true. Can HMRC challenge this tax scheme?

  First and foremost, employee ownership is not a scheme to avoid tax. It is a model supported by government as a means to share corporate ownership more widely and help to create better, more resilient businesses.

  The availability of capital gains tax relief for selling shareholders is written into the legislation that was created in 2014 to better promote employee ownership.

• Does the purchase price need to be paid up front and in full?

  It is typical to leave a significant element of the purchase price deferred as a vendor loan, particularly in employee ownership transactions which are supported by the future profitability and cashflow of the trading business.

  Subject to receipt of a satisfactory clearance from HMRC, 0% capital gains tax will nevertheless apply to the whole purchase price.

• Do I get a 0% tax rate even if the purchase price is deferred?

  The capital gains tax relief will apply to the whole amount of the purchase price, even if only a part of it is paid upon completion of the transaction.

  However, we would always advise that a tax clearance is submitted to HM Revenue & Customs to provide comfort as to the capital tax treatment of the deal structure.

• Must I sell all my shares to benefit from the employee ownership tax breaks?

  The trustee of an employee ownership trust only needs to hold a controlling interest. This means that selling shareholders can retain up to 49% of the business.

• If I don’t sell all my shares right away and want to sell the balance in the future, do I still benefit from the tax relief?

  No. The tax relief is only available for the initial sale, where the employee ownership trust acquires a controlling interest. However, certain owners are happy to leave a minority stake in the business with a view to selling at an increased value that reflects future business growth.

• Can I provide direct share incentives to my leadership team if I sell to an employee ownership trust?

  Yes. Often, hybrid models are created where the employee ownership trust holds a majority stake, but a significant minority stake is offered to senior management either as a direct shareholding or via the grant of share options.

• How do I implement a transition to employee ownership?

  Stage one — value the business

  The business is independently valued and a market share price determined.

  Stage two — secure funding

  It is vital that the business is profitable. The purchase price is typically funded via a mixture of balance sheet cash, vendor loans and external funding.

  Stage three — establish the trust

  All employees must be entitled to benefit from the trust, but entitlements can be flexed based on length of service, hours worked and salary.

  Stage four — transact the share sale

  The transaction is an internally managed process. The vendors will not be required to undergo due diligence and provide extensive warranties and indemnities as are demanded by trade buyers.

  Stage five — embed a culture of employee ownership

  More evolution than revolution, the company should adapt to a culture of employee ownership for a sustainable and profitable future.