How To Exit Your Business - Option 3 Employee Ownership Trusts (EOTs)

The pandemic accelerated an already growing number of business owners considering an exit from their companies – whether for reasons of work-life balance or simply a desire to change industry or location. In his latest series of articles, Corporate Partner Euan McLaughlin, looks at some of the exit routes available to business owners.

No 3 – Employee Ownership Trusts (EOTs)

Employee Ownership Trusts (EOTs) have been around for the best part of a decade, but have only recently begun to gain traction as a “mainstream” option. For the right company, the advantages of sale to an EOT can be very significant.

The idea of an EOT is that, as the name suggests, the company ends up owned by its employees via a trust. The trust would then owe a debt to the sellers of the purchase price, and this would be paid using (i) free cash in the company, and (ii) ongoing profits passed up from the company to the trust.

In order to qualify for the tax reliefs and other advantages afforded by an EOT, the arrangement must meet certain criteria, chiefly:

• The EOT must be for the benefit of all eligible employees;
• It must treat all eligible employees equally (save that you can differentiate by reference to length of service, remuneration and/or hours worked);
• The EOT does not need to acquire 100% of the company, but it must acquire a controlling interest (i.e. more than 50% of the shares, voting rights and profit share);
• The company must either be a trading company, or the parent/holding company of a trading group – this would exclude, for example, certain property-holding companies; and
• Those holding 5% of the company’s shares prior to the transfer (and people connected to them, such as spouses) must not exceed 40% of the total number of the company’s eligible employees.

Key advantages of an EOT include:

• Social benefit of ownership of the company passing to the employees.
• Generally perceived as being an easier negotiation process, as there is no third party “other side”.
• 0% CGT charged on the proceeds of sale. Given that the normal rates of CGT are 20% (or 10% on the first £1m where BADR applies), this could mean a huge increase in the value extracted by the seller(s).
• Ability to pay a cash bonus to each employee each year of up to £3,600, completely free of income tax.
• Ability of directors to remain “in post” with market-rate salaries and packages.

Key disadvantages of an EOT include:

• It is not common for there to be sufficient cash in a company to complete the purchase outright and bank borrowing is not generally an option.  Accordingly, there is usually a period over which the proceeds have to be paid out from ongoing company profits, which leads to uncertainty. This is mitigated here by the ability of the directors to remain in post to give continued stewardship over company performance.

The Corporate Team at Sills & Betteridge have a huge depth and breadth of experience of company sales and purchases, ranging from owner-managed SME businesses to large national and international corporate groups. Please contact Euan McLaughlin on emclaughlin@sillslegal.co.uk or 01522 700490 if you would like to discuss your situation and options.