An employee ownership trust (EOT) is a government-backed initiative that enables employees to take ownership of a company over time.
There were 1030 employee-owned businesses in the UK in June 2022, with EOTs doubling since 2020. It shows the concept becoming more popular across the country, especially in the professional services, manufacturing and construction sectors.
With EOTs growing in number, you may ask what one is and why they’re used. We explore them in more detail.
- What is an employee ownership trust?
- Owner and shareholder benefits
- Employee and business benefits
- How does a sale to an EOT work?
- Considerations
What is an employee ownership trust?
Employee ownership trusts were established under the Finance Act of 2014 to encourage more companies to become employee-owned. The existing company owners may choose to set up a trust (either as part of an exit strategy or upon starting the business).
In an EOT, the owner and shareholders will sell their shares to the trust, which is then held for employees.
Owner and shareholder benefits
The most significant benefit of an EOT is the associated tax relief. When owners sell their shares to an employee-owned trust, there are no capital gains or inheritance tax to pay. It makes it a cost-effective exit route.
There is also a corporation tax deduction up to the value of any bonus payments paid into the trust.
It allows an exit route if the owner doesn’t want a third-party sale, which may take time to find an ideal buyer. An EOT reduces the process length and often limits the associated fees. They will leave the company confident its values will be protected and led by people who know them well.
If the owner wants to retain some control, an EOT will allow up to 49% ownership. Directors have the option to remain in post and receive remuneration packages.
There is also a benefit to shareholders, who have a quicker exit route if they wish to step away from the business. They will also be able to sell their shares at the total value with minimal tax implications.
Employee and business benefits
Alongside the rewards for owners, EOTs benefit employees too.
By giving employees the opportunity of ownership, staff will become more engaged in the daily running of the business and committed to its success. Employee retention, morale and productivity tend to increase as staff become co-owners rather than just workers.
The structure also encourages entrepreneurial input from staff while increasing the use of innovation in the business and driving collaborative processes. Managers also tend to be more willing to train staff and share expertise.
An EOT will also attract people to the company, so it may be used as a recruitment tool to acquire and retain the skills needed for business.
Companies controlled by EOTs can also offer bonuses of up to £3,600 per employee per year with no income tax.
Employee-owned businesses are often more openly run, which paves the way to better corporate social responsibility. This means they offer advantages to local communities, the larger environment, and society.
They also contribute to the UK’s diverse business population, contributing approximately £30 billion to GDP – and growing.
How does a sale to an EOT work?
There are numerous steps to converting your company to an employee-owned via an EOT.
Firstly, you will need to establish a corporation comprised of your trustees. This is known as the Trustee Company.
Your shareholders (including any owners) will then sell their shares to the Trustee Company. It must hold at least 51% of the company’s equity. The Trustee Company will conduct a valuation to determine the market value of shares and, therefore, the purchase price.
Once the shares have been sold, the Trustee Company will owe a debt to shareholders. As the company generates annual trading profits, these will be used to repay the debt owed to shareholders until it is cleared. In some cases, seeking external finance to pay the debt more quickly is possible.
It is worth noting that the Trustee Company will not manage the business, only the trust. The internal management team will retain control, though the trustees want to ensure the business is being run effectively and maximising employee engagement.
Considerations
If you are considering a sale to an EOT, specific criteria exist. The company must be a trading company, and trustees must have at least 51% controlling interest for the structure to work.
The number of continuing shareholders from outside the EOT must also not exceed 40% of the total employees.
Outside of the eligibility criteria, it is crucial to consider whether an EOT is the right move for your company. It’s ideal if you are looking for a friendly exit route, leaving the business in the hands of people familiar with its values and maximising employee engagement.
However, there are many other exit strategies – some of which may be more beneficial (financially or otherwise) for the owners or align better with their goals.
It’s also crucial to ensure your shareholders are informed of an EOT arrangement ahead of time and willing to comply, especially if it means selling their shares.
Finally, employees must receive the same benefits and terms for tax relief to take hold. You must ensure this is the case. If you want specific employees to gain greater privileges, it may be worth looking at a management buy-out.
Conclusion
EOTs offer unique benefits (namely tax reliefs and employee engagement) that make them appealing to businesses.
For owners considering their exit – especially if the prospect of a third-party sale seems unattractive or impossible – it’s a feasible route. It leaves your company in the capable hands of its existing staff, with the option for you to protect your legacy through careful guidance and shared values.
However, it is integral to understand the steps involved in an EOT and ensure it is the right choice for your company – including existing shareholders.
If you are considering an EOT or other exit routes, the Pegasus team will take you through your options and pinpoint the best strategy for your objectives. We also work with you to raise finance to cover the exit and any other support you may need in the lead-up.