What is Employee Ownership?
Employee ownership is where the employees of a business own all or most of the shares in the company. This form of business ownership is rapidly growing in popularity as it offers a number of highly valuable benefits for businesses, their employees and the owners looking at succession planning.
Employee ownership can help companies to retain their independence, reward employees’ hard work and enable outgoing shareholders to receive fair value for the company they have built, amongst many other benefits. It can also be used when setting up a new business, helping to attract talented employees and to create a positive culture.
While employee ownership is gaining a lot of attention at the moment, the concept is not a new one. The John Lewis Partnership was formed as an employee-owned company in 1929 by a visionary of his time, John Spedan Lewis.
We believe employee ownership offers a pragmatic and highly effective option for a wide range of businesses.
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How does Employee Ownership work?
Employee ownership is now usually facilitated with an Employee Ownership Trust (EOT). This was a structure created by the government in 2014 to encourage company owners to sell a controlling stake of the company to its employees.
An EOT is a trust established to hold shares on behalf of employees in a company. EOTs provide a clear framework for employee ownership, as well as offering significant tax advantages for sellers.
To obtain these tax advantages, an Employee Ownership Trust must:
- Contain a controlling interest in the company i.e. greater than 50%
- Be established for the benefit of all employees (excluding, broadly, individuals who hold or have previously held 5% of the shares) in the company
- Treat all employees on an equitable basis
Provided certain rules are met, the transfer of a controlling stake in a business to an EOT gives vendors relief from any Capital Gains Tax ("CGT") that might otherwise be paid. This can therefore significantly increase the effective value of the sale to the outgoing shareholders.
To find out more about employee ownership, you can download our EOT factsheet or request a call from one of our advisers - email email@example.com
Is employee ownership right for your business?
We believe most businesses can benefit from employee ownership, but it can be particularly attractive if you are:
- Looking to retire from a business you own
- Starting a new business and want to attract top talent
- Keen to give your employees a stake in the business
- Wanting to ensure your business can stay independent long-term
To see whether employee ownership could be the right choice for your business, simply request an employee ownership feasibility study.
What are the benefits of employee ownership?
There are many reasons why employee ownership is such an attractive prospect for a wide range of businesses. Done right, employee ownership can be hugely advantageous for existing owners, employees and the overall business.
The following are some of the headline benefits of taking your company into employee ownership:
Getting a guaranteed sale price
Normally, there is no way to know for sure exactly how much you will be able to sell your business for until you place it on the market and see what buyers are willing to pay. However, with an employee ownership sale, the price will be set at a fair market value, so the owners will quickly know exactly how much they will receive from the sale, providing certainty.
Making a business sale tax-efficient
As mentioned above, as long as the right conditions are met, transferring a business into an Employee Ownership Trust (EOT) can allow the sellers to be exempt from Capital Gains Tax (CGT). Employee ownership therefore enables outgoing shareholders to see a significantly larger after-tax profit on the sale of the business.
Ensuring a smooth succession
Selling a business can be a challenging and unpredictable process, with the potential to damage the company if the sale is not handled correctly. Selling the business to its employees can allow for a gradual, carefully planned and managed process, without the need to deal with external parties.
Retaining the outgoing owners’ experience and expertise
The selling owners will often retain a percentage of the ownership of the business and take a reduced role, rather than leaving the business entirely. This can help facilitate a stable transition while keeping the previous owners’ experience available to the business.
Boosting employee engagement
While most companies pay lip service to employee engagement, making employees co-owners of the company gives your team a real stake in the business. This can significantly improve employees’ relationship with the business, leading to greater employee engagement, productivity and loyalty.
Keeping your company independent
When business owners wish to step back from a company, it is often the case that selling to another company is the easiest exit strategy. However, this approach frequently leads to redundancies and a sense that something you have put a huge amount of time and passion into has been swallowed up by a competitor. Employee ownership can allow your business to survive and thrive as an independent entity for many years to come.
How can you use employee ownership for transition planning?
There are various ways employee ownership can be used as part of transition planning.
Business owners who wish to entirely leave the business can place all of their shares into an Employee Ownership Trust.
Business owners who wish to retain a stake and some level of involvement with the business can retain a minority share in the business (a maximum of 49%). They can then stay involved, for example by retaining a seat on the board of directors or as a consultant, without being responsible for the day-to-day running of the company.
A key point to understand is that the new management team and key employees can still receive differential rewards when the business is transferred into an Employee Ownership Trust, just as they would in a management buy-out.
How do you set up an Employee Ownership Trust?
There are various legal procedures and transactions involved in setting up an EOT, but the basic process involves:
- The current shareholders (the vendors) selling anything from 51-100% of the business’s total shares to the EOT. The sellers will usually pay no capital gains tax on the shares sold in the year the EOT acquires more than 50% of the shares
- The EOT pays for the shares with proceeds from third party financing and a loan from the vendors loan.
- The vendors will usually receive payments in instalments and third party financing will be repaid through the contributions from the company.
- As an incentive to align interests, the company may issue shares or warrants/options to key managers and employees.
- Employees will then be eligible to receive income tax-free bonus payments up to £3,600 per employee per annum.
How can a business fund employee ownership?
There are various options for funding employee ownership, with the following being the most commonly used approach.
- The EOT borrows money from lenders (third party senior, subordinated and/or vendor), with a company guarantee.
- The lender takes a charge on the company’s assets.
- The company makes contributions to the EOT to pay interest and fees and to repay the loan (contractual obligation).
- The loan to the EOT is repaid over time through contributions made to the trust by the company.
What are the conditions for tax relief on an Employee Ownership Trust?
For an EOT to offer a tax-free exit route to selling shareholders, it must meet the following conditions:
- It must have a controlling interest in the company i.e. greater than 50%
- It must be established for the benefit of all employees (excluding, broadly, individuals who hold or have previously held 5% of the shares) in the company
- It must treat all employees on an equitable basis
How are employee-owned businesses taxed?
Employee-owned businesses are subject to the same taxes as other types of businesses, but with two important exceptions:
- Transferring a controlling stake into an Employee Ownership Trust will make the sale exempt from any Capital Gains Tax (CGT) that would otherwise need to be paid.
- Each employee can receive an annual bonus payment of up to £3,600 free from income tax.
How much of a controlling stake does there need to be for employee ownership?
At least 51% of the shares in a company must be placed into an Employee Ownership Trust for a business to qualify as employee-owned.
This allows the sellers to retain a stake in the business if they wish, which is a common option for business owners using employee-ownership as part of their retirement planning.
How long does it take to transition to employee-ownership?
This will depend on the circumstances, but one of the advantages of employee ownership is that it can allow a smooth and gradual transition. For example, the outgoing owners might initially retain shares and stay actively involved in the business, with a plan to sell the remainder of their shares and step back entirely after an agreed transition period.
Exactly how you use employee ownership for transition planning and the time frames involved are something you can define based on your goals and any issues you are concerned about, making the process highly flexible.
How are employee-owned companies managed?
Just because a business is employee-owned, this does not mean that every employee needs to be part of the management team. A management structure will need to be agreed as part of the plan to transfer the business into employee ownership.
Employees do need to have a say in how the business is run, however, so this will need to be considered. This might include options such as setting up an employees’ council, having employee directors on the board and having a company constitution to define the business’s values and its relationship with its employees.
How we can help make employee ownership work for you
Our employee ownership team has handled over 1,150 employee ownership transactions with an aggregate value of nearly £1 billion. Our team is well positioned to guide your company through every stage of the employee ownership transition process.
Our feasibility study will demonstrate how an EOT can work for your company. It includes:
We start with a meeting and a request for information that will enable us to form a view of the fair value of your company if it were to be sold to an EOT. To support our valuation work, we look at your company's intrinsic qualities and at the value of recent comparable arms-length transactions in your sector. Later in the process, the trustees will receive a formal valuation opinion reassuring them that they are paying no more than fair market value for the company.
We split the value of the company into the value that can be paid on compilation in cash and value that will be deferred and paid over time through vendor loan votes. We recommend structuring these loan notes to have the same commercial terms as would be required by commercial lender, even if you as vendor choose to waive your right under these terms. This makes it easier for the EOT trustees to justify refinancing your vendor load notes in future, clearing themselves of buyout obligations sooner rather than later.
We show the source and application of funds for an EOT transaction, including a provision for working capital and future capital expenditure. We extend this into medium term and long term illustrative financial projections to show how the business can afford to service the buyout debt with a comfortable margin of safety.
If the transaction structure requires it, and if the company has the financial capacity to support a third party capital raising, we include that option in our feasibility analysis as an optional feature.
We brief you and support you on the whole EOT process from start to finish. We act as project manager, orchestrating the input of lawyers and other professional advisers where needed. We advise you on market practice for selecting trustees and we support you in communications with your employees when the time is right.
Financing an EOT sale
We also help companies that are considering employee ownership to structure and raise capital to support change of control Employee Ownership Trust transactions, so that vendors get fair value and a path to equity.
Speak to us about employee ownership today
For advice on succession planning, to arrange an Employee Ownership Trust feasibility analysis for your company, or simply to find out more about Employee Ownership, please get in touch.
Call – 020 8949 5522 Email – firstname.lastname@example.org
Clarasys, transitions to full Employee Ownership
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