Last updated 17th August 2021
This article is a recap of the June 10th Webinar event: Selling your business to an Employee Ownership Trust – Q&A. A full video recap can be accessed here.
Answering your questions on Employee Ownership Trusts are:
- Andy Ryder: Corporate Finance Partner at Shorts
- Paul Trudgill – Partner at Keebles
- David Robinson – Tax Director at Shorts
If you have a question that is not answered below, our corporate finance team is happy to help. You can email any questions to us through our contact form, and can also download our free EOT guide, which offers further information.
Download the free EOT guide today
What is an Employee Ownership Trust?
“An Employee Ownership Trust is a trust set up for the benefit of all employees. In the EOT transaction, the trust purchases the shares in a trading company from the current shareholders. The EOT ends up being the majority owner of the trading company, and the employees step into the shoes of the current owners, thereby gaining the economic benefits that would normally be accrued by the shareholders.”
Why aren’t Employee Ownership Trusts talked about more?
“I’ve been to several exit strategy events in the past. At those events, nobody ever mentioned EOTs. Why hasn’t this method been discussed more?”
“It is surprising that EOTs are not mentioned at exit planning events. In the right situation, they can be a really good solution. More than this, they are supported by the government and have been around quite a long time (since 2014).
It is true that they have only started to gain traction relatively recently. This is mainly a lack of awareness from the owner manager’s point of view, and potentially a lack of experience from some advisor’s point of view, making them reluctant to bring them to their client’s attention.”
Can a seller retain any control of the business?
“Can a seller retain any control at all of a business that is being sold to an Employee Ownership Trust?”
“It is a key element of the tax relief that the EOT secures a controlling interest in the trading company. This means the seller must transfer more than 50% of the voting rights in the trading company to the trust. The sellers can remain on the board of the company and they can also be trustees of the EOT itself; however, they cannot be the majority for either.
If there is deferred consideration which is payable under the transaction, then the sellers will be major creditors of the trust.
In those circumstances, it is appropriate for the deferred consideration to be protected in the transaction documents. We do this by including provisions, covenants and undertakings in the transaction docs, which prevent the trust and trading company from undertaking activities without the seller’s consent.”
Is an EOT the right choice for a small business?
“There are no statutory size limits for the EOT conditions, so businesses of all sizes can qualify for the relief and benefit from EOT ownership.
One thing to note is that no more than 40% of employees can also be shareholders. An example of this is small, family-owned business where shareholders are parents and children. If the 40% cap is breached, the 0% capital gains tax will not be available.”
How is the purchase price established?
"This is a question we are asked frequently. The purchase price is established through an evaluation exercise. If we were acting in a transaction, we would carry out this evaluation at the start of the process to understand what the market price of the business would be.
We also approach a third party, independent valuer to ensure a robust, fair and independent valuation for all parties before proceeding.
Compared to a trade sale, you are not dependent upon the whims of a small number of trade buyers, which gives you more certainty on price."
How is the Employee Ownership Trust funded?
“The EOT is a new entity and has no cash of its own. The trading business will often have cash on its balance sheet. What we would do is look at this, understand how much cash needs to be retained for working capital purposes, and utilise surplus cash to pay a portion of the purchase price.
We can also go to external funders, such as banks, which can lend the EOT money to fund the purchase price. The funding market for EOT in the UK is still developing, but there are funders out there who will fund EOT transactions for the right companies.
Finally, the purchase can also be funded through deferred consideration. This is a proportion of the price which will be repaid back to shareholders over a number of years.”
How does the EOT pay the balance of any consideration which wasn’t paid at completion?
"The only asset the trust has is the shares in the trading company. This means the trust will only be able to pay the deferred consideration if it receives funds from the trading company. These are usually passed to the trust by the trading company by way of contribution to the trust, out of retained profits.
Often the trust itself doesn’t operate a bank account, and will request that the trading company pays the amount of deferred consideration direct to the sellers.
The trust is the controlling shareholder of the company. In the event that there are funds available, the trust will be able to demand that the trading company makes those payments.
The sellers may also be directors of the trading company, which will give them visibility on the performance of the trading company and its capacity to make the relevant payments.
Finally, we will sometimes take security from the target company on account of the trust’s obligations. This ensures that the debt owed by the trust to the sellers is a secured one, which elevates it against other liabilities. It also gives the sellers a direct means of collecting consideration against the assets of the trading company itself."
What are the tax benefits of an Employee Ownership Trust?
“The government has introduced a number of tax breaks for disposal of companies to EOT. The main benefit is a 0% rate of tax when you sell a controlling stake of a company to an EOT, subject to conditions. This also includes 0% tax on deferred consideration.
If you want to sell a 60% controlling share of your business to an EOT, you will get the 0% rate of tax. Any further shares, such as the remaining 40%, will not. It only applies to the first time the EOT takes control of the business.
An EOT also avoids some nasty inheritance tax liabilities that can arise on a sale under value.
From an employee perspective, tax free bonuses of up to £3,600 every year can be paid to employees, subject to national insurance."
How else do employees benefit?
"Apart from by way of tax free bonuses, how do the employees benefit from an EOT?"
“What we are talking about here are the less quantifiable, but equally important, softer issues. One important benefit for employees is the sense of ownership they didn’t have before. This alignment of objectives has been proven to improve job satisfaction and overall company performance.
An EOT structure is meant to be an enduring ownership structure; this provides a greater sense of job security for the employees than if the company is sold to a trade buyer.
Were the trustees to decide in was in the employees best interests to sell the business later, the capital sum would be distributed amongst all the employees.”
What are the legal differences between EOT and trade sale?
"Is there any difference in the legal process and legal obligations under an EOT compared with a trade sale?"
"There are some significant differences in the legal process and legal obligations under an EOT compared with a trade sale. Perhaps the most important of these is due diligence. If we were to consider a traditional third-party purchase, you would expect the buyer to undertake full due diligence. Due diligence would not be expected under an EOT transaction.
Secondly, a third-party buyer would expect protection from risk, and to ensure there are warranties and indemnities in the transaction. In an EOT transaction, the only warranties given by the sellers would be as to their ownership of the shares and their capacity to transfer them to an EOT.
Thirdly, a third-party buyer would usually require the seller to sign up to significant restrictive covenants to give the buyer comfort that their purchase is protected over an extended period."
Do all employees benefit equally from an EOT?
"It is important to note that employees do not own the shares in an EOT backed business; they are beneficiaries of the trust.
In general, all employees benefit from the trust on equal terms. This is one of the conditions for the 0% tax rate.
The trustees do have power and flexibility to differentiate between different employees, based on factors like length of service, working hours and salary.
In order to continue incentivising senior management, we sometimes run an equity incentive scheme alongside the EOT, which gives share options to senior employees who want more equity."
Are there any other areas for owner/managers to consider when selling to an EOT?
"While tax advantages of an EOT are very attractive, there are various other considerations which should be made before proceeding with the disposal.
Sellers will need to ensure there is a capable team in place to take over leadership responsibilities to ensure the long-term success of the company.
We would always recommend exploring all exit strategy options and understand the pros and cons of each before deciding.
If you decide EOT is the right solution for you; one of the key benefits for the seller is the certainty of price and timescale."
Got another question?
Whether you missed the original broadcast or thought of another great question afterwards, we are always looking for more questions to answer about Employee Ownership Trusts and how they work. If you have a question that was not answered here, you can find out more information in our free EOT guide. Alternatively, send us a message today and we will get back to you.