What is an Employee Ownership Trust?
Employee Ownership Trusts or ‘EOT’ were introduced by the government in 2014, and are a structure to allow businesses to be owned by employees. Ultimately, what you do is set up a trust and the trust holds the shares in the business on behalf of the employees. The decisions regarding the trustees are made by the trustee directors, and they’re usually a mixture of employee representatives, maybe a founder shareholder, and also potentially an independent director as well.
Why would a business owner sell their company to an EOT?
There are a number of reasons why a business owner may want to sell their company to an Employee Ownership Trust. The principal one is retaining talent within the business and boosting employee engagement. What you’re essentially doing with an EOT is handing over control of the business to the employees so they’ll feel much more engaged in decision making by helping to run the business. It also tends to be an easier transaction to negotiate too, as you are selling the business to employees who already know the business. This is especially true if you are using cash within the business to actually fund the deal.
The other key benefit of Employee Ownership Trusts is that the government is incentivising founder shareholders to look at selling their businesses to EOTs by charging no tax on the sale proceeds, which means the sale proceeds come out completely tax free.
Does a sale to an Employee Ownership Trust suit all businesses?
No, it doesn’t, and it’s a key question at the outset for a founder shareholder to consider. You need to have a look at the business and decide whether it has a strong leadership team that sits below the current management team who may well step to one side slightly. It also depends on the nature of the business as to whether that sort of employee engagement is going to suit that business.
From a founder shareholder perspective, you need to consider whether they are happy to step to one side and pass control over to the employees. That’s a fundamental question.
Do the founders have to leave the business after a sale to an EOT?
No, not at all. In fact in most of the deals we’ve dealt with, the founder shareholders have huge amount of experience and expertise and if they left the business, it would be pretty detrimental. In the deals we’ve done, the founder shareholders have remained in the business, they haven’t stepped away from the leadership but have just handed over control. This means they are still influencing some of the decision making and bringing their expertise and experience to the business.
How is the sale of an Employee Ownership Trust funded?
The most common one is actually using the cash in the balance sheet of the business to fund the sale proceeds. So whatever cash in the business is contributed up to the Employment Ownership Trust, and then used to pay the founder shareholders. Any future cash generated by the business can be used to fund any deferred consideration that might have been agreed on the deal.
Another option would be that the trustees of the EOT can go out and get bank debt and raise debt that way. The bank will need to just get comfortable with the structure of the deal and the management of the business moving forward because Employees Ownership Trust structures are slightly complicated.
What requirements do you need to meet to qualify for tax benefits of selling to an EOT?
One key thing about selling your business to an Employee Ownership Trust is there is quite a lot of legislation around it. It’s a real box ticking exercise and you can trip yourself up if you don’t follow the legislation, so it’s really important to meet all the criteria.
The founder shareholders have to sell a controlling stake of the business. They have to sell 51% or more of the business. That’s a fundamental part of the transaction. The other part is that the trust has to be set up for the benefit of all employees in the business and the employees themselves have to be treated equally and equitably.
Getting advice on Employee Ownership Trusts
The first thing to do would be to get some advice because it is a very technical area and it’s also a developing type of transaction. People are learning as they go through the transactions with the do’s and don’ts. You certainly need advice, and in that same conversation it’s worth considering whether this route to selling the business is the right one for your business and for you. Is the nature of the business suitable for employees taking control? Could the seller rather secure a higher price by going to the market and trying to sell to a trade buyer? There are lots of considerations to bear in mind though. Get an independent valuation of the business so you can get an idea of the true and real value of the business.
You should also consider how the deal might be structured. How much cash can be paid on completion? How much of it needs to be deferred, and over what sort of the term? What you don’t want to do is put the business under huge cashflow pressure by lumping a load of debt on the balance sheet. Finally you should think about your culture – some businesses don’t suit Employee Ownership Trusts due to their cultures, so considering this is also a key consideration as well.
If you would like to speak to our team of expert advisers on Employee Ownership Trusts, or any other Corporate Law please do reach out.
