An Employee Ownership Trust (EOT) is an alternative business ownership structure with specific benefits to both owners and employees. It involves the employees of the business holding a controlling stake in a trading company via a specifically designed trust, often appointing an advisory council and operating to a set of previously agreed on principles for the future management and progression of the company. This is intended to facilitate participation and engagement in the running and direction of the business, with benefits for both corporate governance and profitability.
EOTs were originally introduced by the government in September 2014, in an attempt to encourage more shareholders to set up a corporate structure similar to the "John Lewis model", by offering significant tax breaks. However, it took until the 2020/2021 tax year for the utilisation of EOTs to substantially spike - this is likely due to the impact of the COVID-19 pandemic, felt especially hard in the retail sector, and the anticipated rise in UK Capital Gains Tax.
The John Lewis Partnership has the largest EOT model in the UK. More recent corporates to become EOTs are hi-fi retail business Richer Sounds, with Julian Richer, Founder and MD of Richer Sounds transferring 60% of his shares into an EOT, and organic food retailer Riverford Foods, with founder-owner Guy Singh-Watson transferring 74% of his shares into an EOT. in discussion with such founders as to why this route has been chosen, reasons quoted include:
- the building of a solid platform for growth;
- improving job stability;
- rewarding employees that have contributed to the success and growth of the company;
- retaining existing cultures;
- empowering everyone to drive the business forward; and
- the creation of a legacy for future succession planning.
Leading forecasters have shown that the number of EOTs is increasing at a rate of 40% per annum. With market leaders within the sector choosing this route of succession, there has been a notable spark in the level of interest in this model, and whether or not it could be viable for smaller businesses within the sector.
How does it work?
The sale of a company to an EOT works as follows:
- A qualifying EOT will be established with a corporate body as the trustee of the EOT (the Trustee Company);
- The shareholders sell their shares to the Trustee Company under a share purchase agreement. The shareholders and the Trustee Company will jointly engage a share valuation expert to value the company: the Trustee Company will use this value as the basis for determining the purchase price. On the sale of the shares, the purchase price may be partially third party financed however it is likely that this will largely be left outstanding and will create a debt owed by the Trustee Company to the shareholders;
- The company will continue to generate trading profits each year and it will use these profits to make contributions to the EOT;
- The EOT will use these contributions to repay the outstanding purchase price that it owes to the shareholders.
What are the advantages?
The advantages for the selling shareholders are:
- It allows employees to indirectly buy the company from its shareholders without them having to use their own funds, thereby creating an immediate purchaser and addressing succession issues;
- Shareholders can sell their shares for full market value (an independent valuation will be required);
- No capital gains, income or inheritance tax liabilities should arise on the disposal of a controlling interest in a company to an EOT (or on the subsequent receipt of the purchase price by the former shareholders);
- Not all shareholders are required to sell their shares to the EOT;
- The directors can remain in situ post-disposal and can continue to receive market-competitive remuneration packages;
- The EOT is generally seen as a "friendlier purchaser" which means the sale process may be quicker, with potentially lower fees;
- Companies controlled by EOTs are able to pay tax-free cash bonuses to their employees of up to £3,600 per employee per year.
What are the disadvantages?
An important point to be aware of when a company is sold to an EOT is that the purchase price is fixed at the point of sale. Therefore, should the value of the company increase post-disposal, the selling shareholders would not be entitled to any additional consideration.
Due to the fact that sales to EOTs are generally financed through the post-tax profits of the trading company, it is important that the trading company remains profitable and cash-generative post-disposal. Should the trading company become loss-making then it may be unable to make payments to the EOT which in turn would mean that the trustee of an EOT may be unable to pay some, or all, of the deferred consideration.
Employee engagement - It is important to ensure that the EOT is represented adequately in order to avoid conflicts between directors and shareholders. To establish effective employee governance and ensure transparency, the following steps could be taken:
- The appointment of employee representatives to the board of directors;
- Elect employees to form an employee committee/council to be consulted by the board of directors;
- The steps outlined above allow employees to become co-owners of the business. This could significantly improve employees' relationship with the business and boost employee engagement, productivity, and commitment as well as having a significantly positive impact on employee retention and even future employee recruitment;
- Controlling interest requirement - The EOT is required to acquire at least 51% of the businesses' total shares to qualify as employee-owned to attract all of the benefits outlined above. A partial sale will allow the shareholders of the business to retain a stake in the business. This is beneficial for owners who intend to use the EOT as part of their retirement/exit planning.
Is an EOT right for you?
You should consider a sale of shares to an EOT if:
- You don't feel a trade sale or management buyout is feasible or the best solution;
- You wish to sell your shares, but are struggling to find a third-party investor in the current climate;
- You are looking to take advantage of the generous tax breaks, in light of recent proposals to increase CGT.
We strongly recommend that you seek tax/financial advice before proceeding with any company restructuring or sale of shares.
For more information contact David Filmer in our Retail department
via email or phone on 0333 207 1132.
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