The growth of Employee Ownership Trusts

Since the enactment of the Finance Act 2014, the popularity and acceptance of the Employee Ownership Trust (“EOT”) as an exit option for business owners has continued to gain support from lawyers, accountants, the Institute of Chartered Accountants in England and Wales and business owners themselves.

2019 saw Richer Sounds joining a growing group of employee owned business through EOT structures such as Ardman Animations together with a regional law firm.

Quite simply the ability to choose an exit date, with the considerable tax benefits on disposal compared to conventional exit methods, especially at a time where practitioners are anticipating further curtailment of Entrepreneurs Relief means that growth of the model will continue.

How does it work?

By way of brief overview, shareholders sell their shares to a trust, the beneficiaries of whom are the employees.  The sale price is satisfied by the Company transferring out the profits of the company to the EOT who in turn pays the selling shareholders for the shares.

The tax reliefs for a qualifying EOT include:

• A capital gains tax (CGT) relief for a disposal of shares to an EOT.
• A limited exemption from income tax on bonus payments of up to £3,600 per year paid to employees by companies owned by EOTs.
• Relief from inheritance tax on certain transfers into and from EOTs.

Considerations in setting up an EOT:

• Who will be the trustee? There may be the potential for a conflict of interest if an employee or director of the company is also a trustee. It is possible for an EOT to have an offshore trustee.
• What will be the governance structure of the company and the EOT?
• What is the market value of the shares that the trustee must acquire in order to have a controlling interest in the company? The trustee may need independent expert valuation advice.
• How will the trustee raise the funds to acquire the shares? How will the trustee repay any indebtedness it incurs and any interest on that debt?
• Need for Sellers and Trustees to be separately advised.
• Whether external support is required to transition the change management.

There are a number of requirements to qualify as an EOT – these include: 

• Meeting the “all-employee benefit requirement”
• Meeting the “equality requirement

How will the purchase be financed?

There are a number of ways that this might be achieved, including:

• Trustee borrows money from a bank.
• Company borrows money and lends it to the trustee.
• Company borrows money and makes contributions to the trust.
• Seller sells shares on a deferred payment basis (vendor finance).

Will the conditionality be satisfied to claim the tax reliefs?

There are certain conditions that have to be met both:

• By the trustee and the trust deed of an EOT in relation to the CGT relief.
• In the operation of a bonus scheme to secure the exemption from income tax on bonus payments.

Does the existing structure and culture of the business support this type of ownership and what involvement can the sellers have in the running of the business after disposal?

In conclusion, we anticipate the growth and popularity of the EOT as an exit model for business owners to continue well into this decade.  For further information on EOT’s business sales or corporate law generally please do not hesitate to contact our team.