Becky Maguire, Tax Partner at Connect Yorkshire Partner Garbutt+Elliott, explains why business owners are increasingly considering selling to an Employee Ownership Trust (“EOT”) and how in the right situation they can be a fantastic solution.
Business owners looking for a sale route for their business are increasingly considering selling to an Employee Ownership Trust (“EOT”). EOTs have only recently come onto the radar of many companies and their advisers but in the right situation they can be a fantastic alternative to a trade sale or a Management Buy-out. Rarely a week goes by without a news story about the latest business to move to employee ownership. But what on earth is an EOT, why now and what are some practical points to take away?
What is an EOT?
An employee trust is quite simply a trust set up to act in the interests of the employees of a business. More specifically an EOT is governed by rules introduced by the government in 2014. These are mainly designed to ensure that the trust operates only in the employees’ interests, but they are also important for the tax position of both the vendor and the EOT itself. The tax incentives of an EOT are there for both the vendor (0% CGT) and the employees who can receive up to a £3,600 bonus every year income tax free.
A typical structure involves the current shareholder(s) selling a majority shareholding in their business to an EOT at market value. The cash consideration received by the vendor is often on deferred terms so that the company can pay it over a period of time. Some EOT structures involve external finance. What they all have in common is the majority ownership of a business by its employees. It is important to note that, unlike some other forms of employee ownership, employees do not own the shares individually – it is the trust which is the shareholder, and which acts in the employees’ interests.
In our experience working on several EOT projects, there are 4 main factors at play in the current attractiveness of EOTs.
There is no doubt that the 0% Capital Gains Tax (CGT) headline makes people sit up and take notice. Never more so than now when the current low rate of CGT appears to be under threat.
Some business owners are appreciating the fact that employee ownership provides them with a valid exit route. The Covid-19 pandemic has in some cases accelerated a decision to exit and to ensure the success of the business over the long term.
The relative simplicity of an EOT sale is attractive for some business owners who may have been through deals in the past and do not have the appetite to do so again or indeed do not want their business sold to a competitor or a larger player.
Finally, the fact that EOTs are being talked about more and advisers are becoming comfortable with them in itself means they are in the melting pot in conversations about business sales and succession.
Practical points to note
Whilst EOTs are relatively simply to implement compared to a third-party trade deal, it is important that advisers are joined up and understand the specific rules that apply. In our experience, corporate finance, tax, accounting, and legal advisers need to work together as a closely knit team alongside the shareholder(s).
The cash flow forecasting model and valuation that support the sale to the EOT needs to be robust – not least to ensure the EOT is paying a fair market price for the shares but also to support the affordability of the vendor’s deferred consideration.
In our experience, engaging with both the proposed trustees of the EOT and the wider employee base is an important part of the process and should not be overlooked. The positive culture and motivation that can be created via an EOT is worth harnessing and engaging employees in the right way will help achieve this.
Selling to the EOT does not mean that you have to hang your boots up, you can remain in the company and carry on running the business on a day to basis if you are planning a longer exit route.
Last but by no means least given its importance, it is worth remembering that the 0% CGT must be claimed. Make sure your tax adviser has this in hand!
If you have any questions about any of the points raised above or want to know more about EOTs, please do get in touch.