Employee ownership is not a new concept (think John Lewis) but its popularity in the small business community has exploded in recent years.
I frequently have conversations with business owners in Scotland who are thinking about the future and wondering whether a transition to employee ownership might be the way forward.
If you’re in this position, we can help.
What is employee ownership?
There are essentially two models, and they may not be mutually exclusive:
- Direct share ownership
- Employee trust
I have written elsewhere about some of the direct share ownership approaches (such as this article on EMI share options) but in this piece I'd like to focus on the trust model, specifically 'Employee Ownership Trusts' (EOTs for short).
EOTs were introduced in 2014 in response to the Nuttall Review, in which the government explored ways to actively encourage employee ownership.
They’re designed to promote and encourage employee ownership by enabling business owners to sell a controlling stake to an employee-controlled trust, without incurring Capital Gains Tax.
The employees do not own or control the shares directly – rather, they are held by the trust, for the benefit of the employees.
It is thought there are now more than 1,650 employee-owned businesses in the UK and the concept continues to grow in popularity.
The benefits of using an EOT are numerous:
- It’s an attractive alternative to a 'trade sale' where a third-party purchaser cannot be identified
- It can provide a smooth and minimally disruptive exit, relative to other options such as an MBO or trade sale
- Owners can retain a minority shareholding, if desired
- UK shareholders can sell their shares free from Capital Gains Tax
- Flexibility exists for management and key employees to hold some equity directly, e.g. via EMI options
- It often improves employee retention, engagement, and productivity
- An annual tax-free bonus of up to £3,600 can be paid to employees of an EOT-controlled company
A critical question for the selling shareholders is: “How will I be paid for my shares?”
Typically, there will be insufficient cash in the company at completion to enable the shareholders to be paid all the consideration immediately.
Therefore, the EOT will usually pay the selling shareholders over a period of time, out of future income generated by the company.
A selling shareholder might typically become one of the trustees of the EOT (either directly or on the board of a corporate trustee), along with an employee representative and an independent trustee.
They might also remain on the board of the company for a period of time post-completion, not just to help an orderly transition to new management but also because they have a strong financial interest in ensuring that the company continues to trade profitably.
The governance arrangements of the EOT and the company must be carefully structured to ensure that there is a genuine change of control, in line with the requirements of the EOT legislation.
Ultimately the EOT is there to ensure the company is run for the benefit of the employees, rather than the current owners, though the interests of both parties are often closely aligned.
How do we help with EOTs?
Our involvement in supporting our clients with a transition to the EOT model typically involves:
- Reviewing the suitability of the EOT model and comparing with alternative exit approaches, to ensure the right path is chosen.
- Advising on the tax aspects of the deal (often there will be related matters e.g. the exercise of EMI options pre-completion), to ensure that tax costs are appropriately managed, minimised, and to secure expected beneficial tax treatments.
- Performing share valuations to confirm a fair valuation for the shares, which can help prevent unexpected tax charges.
- Assisting with employee communications.
- Liaising with the legal team involved in drafting the deal documentation.
