What are Employee Ownership Trusts?

Are you looking to sell your business whilst also giving back to your hardworking staff?

Typical share sales of businesses frequently lead to:

  • A full due diligence process given the buyer’s lack of knowledge of the business and full negotiations over the terms of the sale;
  • An inability for the sellers to influence the long-term future of their business;
  • Large payments of capital gains tax by the sellers for the sale of their shares; and
  • Significant disruption for staff, potential culture clashes and redundancies.

These issues will not typically arise if you sell your business to an Employee Ownership Trust (EOT), which have increased in popularity in recent years. The Employee Ownership Association recently reported that in June 2022 there were 1,030 employee owned businesses, and by December 2022 this number had grown to 1,300.

In short, an EOT is a trust (usually with a company limited by guarantee as the trustee (Trustee Company)) which purchases a ‘controlling interest’ in a company (the Target Company) (i.e. more than 50% of the share capital), and holds the shares purchased on behalf of the company’s employees.

Why sell to an EOT?

EOTs were introduced in 2014, during the Conservative – Liberal Democrat coalition, to incentivize employee business ownership by providing generous tax reliefs. For example:

  • There are no charges to capital gains tax for the sellers selling their shares to an EOT. By way of example, this would equate to a saving of between £500,000 to £1,000,000 for a business sold for £5,000,000, depending on the individual seller’s tax rates;
  • There are no charges to income tax for bonus payments made by a company owned by an EOT to employees (up to a maximum £3,600 per employee each year); and
  • There are inheritance tax reliefs for disposals of property and transfers of shares to an EOT in some circumstances.

However, most companies with an employee ownership structure do not cite these reliefs as the primary motivating factors behind selling to an EOT. Other factors include:

Identity and control – EOTs help preserve the identity and structure of your business because they allow you to keep the same management structure. It is not uncommon for sellers to continue their involvement in the board of directors post-sale, whereas on a normal share sale, such a seller would typically cease their involvement in the board on completion. The sellers can still benefit from income and capital gains tax reliefs whilst collectively holding up to a 49% shareholding in the company, provided their individual shareholdings and involvement in the company does not exceed certain thresholds.

Giving back – An EOT allows the employees who made the business successful to benefit both financially and culturally. The trustees of the EOT do not have a role in management of the business, but instead ensure the business is run in a way which maximises employee participation and engagement. Employees also benefit from no income tax charges on bonus payments up to £3,600 per employee each year. Although, employees will continue to pay income tax on any bonuses they receive above this limit, salary, and wages.

Motivating staff – Giving employees a form of ownership in the business motivates them to work hard for what is now their own, and increases staff retention due to their personal incentive to make the business successful. Staff are also made to feel more valued for by the business, due to the voice their interests are given through the trustee.

Establishing an EOT

Setting up an EOT involves the Trustee Company and the Target Company executing a trust deed, which establishes the rules governing the EOT. The beneficiaries of this trust structure are whoever the employees of the company are at any given time (i.e. employees who join the company after the establishment of the EOT become beneficiaries of the trust, and those who leave cease being beneficiaries). To complete the transaction, the selling shareholders and the Trustee Company would then execute a share purchase agreement for the shares in the Target Company.

Our Corporate Team at Herrington Carmichael have significant experience in transactions involving EOTs. To speak to us about how we can assist you, please call 0118 989 9708, or alternatively email sophie.protheroe@hc.law.

Sophie Protheroe
Solicitor, Corporate
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This reflects the law and market position at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought in relation to a specific matter.

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