When contemplating exit strategies, business owners face several options.
Employee ownership provides an increasingly popular alternative to the more traditional exit approaches (e.g. trade sale) for SMEs which fit certain criteria.
Legislation introduced in the Finance Act 2014 created a new framework to encourage wider adoption of the employee ownership model, and we have since assisted clients to move to employee ownership using Employee Ownership Trust (EOT) structures.
What are Employee Ownership Trusts?
EOTs provide a tax-efficient way for business owners to exit the business whilst ensuring operational continuity, maximising employee engagement, and rewarding those who have contributed to the company's success.
Essentially, the owners sell a controlling stake in the company to the EOT which holds the shares for the benefit of the company’s employees.
Setting up an EOT requires meeting the eligibility criteria, with a key stipulation being that the trust gains a controlling interest, ensuring employees truly benefit from ownership and financial gains.
Consideration for the shares is commonly funded with debt and/or out of expected future profits of the company and, for this and other reasons, the exiting shareholder(s) will often continue to play an active role in the company for a period of time after the EOT first acquires the shares.
Exiting shareholders can retain a minority stake after selling a controlling shareholding to the EOT, and many choose to do so.
Advantages of EOTs over other exit options
Employee ownership promotes operational continuity and strong levels of employee engagement post-sale and can often be less disruptive than a trade sale or other forms of exit.
Whilst tax reliefs should not be the driving force in any decision to move to employee ownership, the tax breaks are very attractive, particularly for the exiting shareholder(s) who can benefit from complete relief from Capital Gains Tax (CGT) on any gain that arises when a controlling shareholding is sold to the EOT.
The benefit of the CGT relief (relative to that available in other forms of exit) is more sharply in focus now that the BADR lifetime limit is reduced from £10m to only £1m.
Moreover, the business and its employees might enjoy further tax benefits, enhancing the overall appeal of this exit strategy.
Knowing that they have a stake in the success of the business, employees are likely to be more committed and motivated which has a positive impact on retention and recruitment but also contributes to a more vibrant company culture.
Furthermore, EOTs help with the preservation of the business's ethos and values, which can be harder to achieve where control of the business is ceded to a third party.
An EOT allows for a smoother transition in business ownership with minimal operational disruption.
Tax breaks
Looking at the tax breaks in more detail, EOTs offer a relatively tax-efficient exit strategy for business owners, with specific incentives designed to encourage this form of business transfer.
In addition to the CGT relief discussed above, there is a specific tax break for employees of the employee-owned company who can receive annual bonuses of up to £3,600 free of Income Tax.
Other considerations
Transitioning to an EOT requires careful planning and is not a journey to be undertaken without careful consideration.
Before heading down that road, owners need to be sure that employee ownership is the best option to promote the company’s future. It requires the right team and the right organisational culture.
Cultural considerations aside, also think about:
- Professional costs: The right professional advice (across legal, tax and other disciplines) must be sought and this, inevitably, comes at a cost which may not be insignificant. A fair market valuation of the business will need to be obtained to establish the price at which the trust will buy the shares. This process can be complex and necessitates professional advice from a qualified accountant.
- Financing the sale: If the EOT does not have sufficient funds to buy the business outright, the sale might be financed through deferred consideration, requiring careful financial planning and potentially introducing additional risk, relative to other exit options.
- Ongoing governance: Running an EOT involves governance and administrative responsibilities, which can incur ongoing costs.
Summary
Choosing between employee ownership and other exit options involves weighing the immediate financial benefits against long-term outcomes.
Selling a company to a third party can sometimes enable a swift exit with some or all the value realised very quickly, but (relative to employee ownership) may come with higher taxes and potential integration challenges.
Employee ownership, by contrast, can offer significant tax advantages and foster a positive company culture, although it requires careful financial structuring to manage the transition and ongoing costs, and may introduce additional risk for the exiting shareholder(s) where part of the sale’s proceeds are deferred and dependent on continuing profitability.
For business owners, the decision should align with their financial goals, desired legacy, and the well-being of the employees who have been instrumental to the business's success.
With that in mind, perhaps you are considering if employee ownership is the right exit strategy for you and your business.
If that’s the case, please consider speaking to a member of our team. We are experts in developing, managing, and integrating EOTs to facilitate business exits.
