Employee Ownership Trusts (“EOT”)

What is an EOT?

 

An EOT is just one of various ways of structuring indirect employee ownership of a business, where shares are held by a trust established to hold the shares in a company. The intention behind the EOT structure is for the trust ownership to benefit employees over the long term through the trust influencing the company’s direction, as opposed to key individuals profiting from dividends or a growth in share value, with an eye on an exit.

 

When an EOT is used there is usually a strong emphasis on succession planning with the intention for the business to pass to the next generation without necessarily taking on outside partners; protecting the independence, values and foundations of the business.

 

The structure of an EOT purchase can allow the employees to indirectly buy the company from its shareholders without them having to find and use their own funds, thereby creating an immediate purchaser and addressing possible succession or acquisition market issues.

 

Advantages of an EOT structure

 

In addition to the potential tax advantages set out below, there are a number of advantages in a sale of a company to an EOT:

 

– On a sale to an EOT, providing key qualifying conditions are satisfied, shareholders can choose whether to sell some (but must at least be a controlling interest) or all of their shares.

 

– It allows the current directors to remain in situ following the sale and they can continue to receive remuneration packages in line with the market.

 

– An EOT is seen as a friendlier purchaser than, say, a private equity purchaser. The negotiation of the sale documentation is usually less protracted and the terms of the warranties and indemnities contained in the share purchase agreement should be less aggressive due to the relationship of the trustee with the target company.

 

– The trading company usually continues its day to day operations in a similar manner after the sale to the EOT, without the potential restrictions a private equity buyer might impose.

 

– As all employees get an indirect stake in the company there are certainly potential practical benefits associated with being owned by an EOT, such as:

 

* increased employee engagement and commitment;

 

* a greater drive for innovation; and

 

* overall improved business performance.

 

Tax advantages

 

There are two main tax advantages:

 

1. no capital gains tax is payable by individuals who sell a majority stake to an EOT (however there are caveats to this to watch out for!); and

 

2. EOTs are able to pay tax-free cash bonuses to their employees of up to £3,600 per employee per year (again, there are conditions to be aware of here).

 

Things for shareholders to consider

 

Shareholders must consider that when a company is sold to an EOT the purchase price is fixed at the point of sale. Therefore, should the value of the company later increase, the selling shareholders would not be entitled to any additional consideration.

 

Due to the way in which these transactions are generally financed, it is important that the trading company remains profitable and cash-generative following the sale because any deferred consideration due to the sellers is usually financed via the post-tax profits of the trading company; should the trading company become unable to make payments to the EOT this in turn would mean that the Trustee Company may be unable to pay some, or all, of the outstanding deferred consideration to the sellers.

 

* It is important that the composition of the board of a Trustee Company is considered carefully as there is potential for director and trustee conflicts of interest, which could result in personal liability.

 

* Robust sale transaction documentation (for example, the EOT trust deed and Target Company articles) will need to be drafted to ensure that the key qualifications are met at the time of the sale and will continue after the sale, as far as practicable, avoiding any “disqualifying events” which could trigger nasty tax consequences.

 

How a sale to an EOT (usually) works:

 

A qualifying EOT will be established with company as the trustee of the EOT (the “Trustee Company”).

 

The shareholders sell their shares to the Trustee Company under a share purchase agreement. The purchase price will be determined by a jointly engaged share valuation expert to value the company. On the sale of the shares, the purchase price (or such part not paid on completion of the sale) will create a debt owed by the Trustee Company to the sellers which will be left outstanding as deferred consideration (now commonly referred to as ‘vendor finance’).

 

– The target company will continue to generate trading profits each year and it uses these profits to make contributions to the EOT (usually by gift). The EOT will in turn use these contributions to repay the deferred consideration that it owes to the sellers.

 

Example EOT ownership structure

 

  • If you need any help or advice on selling your company or employee share incentives please contact Nikki Reid.

 

Useful Links

  • The Employee Ownership Association’s website (here) is a useful resource for those considering employee ownership.

 

Murrell Associates 09 September 2020

The information provided in this article is a summary for general information purposes only and does not constitute legal or other professional advice and cannot be relied upon as such. Any law quoted in this article is correct as at the above date. Appropriate legal and financial advice should be sought for specific circumstances before any action is taken.