What is an Employee Ownership Trust?
Employee Ownership Trusts (EOT) were created by the government in 2014 as a structure to facilitate company owners selling a controlling stake to its employees.
An EOT holds shares in a company on behalf of employees, making it a form of indirect employee ownership. EOTs provide a clear framework for employee ownership, as well as offering significant tax advantages for sellers.
How does an Employee Ownership Trust work?
To set up an Employee Ownership Trust, the sellers or company founders will need to place a majority of the business’s shares into the trust. The EOT will then hold those shares for the benefit of the company’s employees, with the business’s profits being paid to the trust.
What are the conditions for tax relief?
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 to 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% to 100% of the company’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.
- The vendors will usually receive payments in instalments and third party financing will be repaid through contributions from the company.
- As an incentive to align interests, the company may issue shares or options to key managers and employees.
- Employees will 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 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 to repay the loan (contractual obligation).
- The loan to the EOT is repaid over time through contributions made to the trust by the company.
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).
- 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.
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 having employee directors on the board and having a company constitution to define the business’s values and its relationship with its employees.
What happens if an employee wants to sell their shares?
An EOT holds shares on behalf of all employees and all employees do not have a direct claim on individual shares in the EOT.But they can be offered shares alongside the EOT.Where this happens the process for employees selling their shares will need to be established. Typically, employees will be required to offer their shares for sale internally, for example to the EOT.
What happens when employees leave an employee-owned business?
Again, this is something that will need to be determined when the company is first placed into employee ownership and is only relevant where employees own shares individually. It is normal for employee-owned companies to require employees leaving the business to sell their shares back to the company or the EOT.
How can employee ownership be used for succession planning?
There are various ways employee ownership can be used as part of transition planning.
Business owners who wish to leave the business entirely can place all 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 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 succession planning and the time frames involved are something you can choose based on your goals, making the process highly flexible.
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