What is an Employee Ownership Trust?
An Employee Ownership Trust (EOT) is a type of employee trust used to encourage shareholders to set up structures such as the John Lewis model which facilitates employee ownership.
Provided certain conditions are satisfied, business owners can sell their shares free of capital gains tax. This can generate significant savings compared with a traditional share sale which could be liable to tax at up to 20%. Employees also benefit as they can receive tax-free bonuses of up to £3,600 per year.
How does it work?
A trust is set up and the existing shareholders sell shares in their trading company to the trust for market value as determined by an independent valuer. The sale consideration will usually be in the form of cash and loans which is left as outstanding, thereby creating debt in the trust. The debt is repaid to the shareholders by the trust over a period of time funded out of future profits of the company. External funding can also be arranged to provide immediate payments to shareholders if necessary.
The employees own shares in the company indirectly through the trust as beneficiaries.
A typical structure of an EOT is shown below:
- Facilitates a quicker exit compared to a traditional third-party sale – there is no need to find an external purchaser and to be involved in complex sale negotiations with numerous professional advisers.
- Employees can receive tax-free bonuses of up to £3,600 per year.
- Enables employees to indirectly acquire the company without using their own capital.
- Research has shown that employee-owned businesses achieve higher productivity and innovation compared with other business structures and are more resilient to economic downturns.
- Share incentives schemes can be offered to key employees of the management team in combination with the EOT to aid further growth.
- Following payment of vendor debt, profits can be retained within the company for reinvestment, higher salaries and/or bonuses for employees resulting in further growth and incentivisation.
There are various conditions that need to be met which have been highlighted below:
- Trading requirement – The company must be a trading company or a holding company of a trading group.
- All employee benefit requirements – The trust must be set up for the benefit of all eligible employees, which can only be varied according to remuneration, length of service and hours worked.
- Controlling interest requirement – The trustees must retain, on an ongoing basis at least a 51% controlling interest.
- Limited participation requirement – The number of continuing shareholders who are directors or employees (including any connected persons) must not exceed 40% of the total number of employees.
In order for the sale to qualify, the conditions need to be monitored carefully to ensure they are met prior, during and post sale to prevent any clawback of tax reliefs.
If you are considering a full or partial sale of your trading business and would like to explore the possibility of selling to an EOT as an alternative to a management buyout or third-party sale then please get in touch. If you would like more information or any.
Information for readers: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.