Employee ownership trusts explained

The trend of selling businesses to employee ownership trusts (EOTs) continues to gain momentum, particularly among owner-managed and family businesses.

The appeal of EOTs lies not only in their potential tax benefits to sellers (0% capital gains tax) but also in their ability to preserve the company culture and increase employee engagement through a greater sense of ownership and responsibility. However, EOTs may not be the right fit for every business, good advice is needed to navigate the variety of complex issues. In the article, we explain what employee ownership trusts are and cover what you need to know.

Employee ownership trusts after the Budget 2024

With the main rate of capital gains tax increasing to 24% with immediate effect in the recent Budget as well as business asset disposal relief increasing to 18% on the first £1 million of gains by April 2026, a sale to an EOT at 0% looks even more appealing as a tax efficient succession strategy.

However, the October Budget 2024 also introduced measures to prevent abuse of the EOT structure. These included ensuring that the seller does not control the trust post-sale, extending the clawback period for tax relief and ensuring that the business is not sold above its market value, amongst others.

Funding the deal

External funding for EOTs is becoming more accessible, allowing shareholders to increase their initial cash out. A broader range of lenders, especially those in alternative finance, are now familiar with the nuances of EOTs and their ownership structures.

Lenders prefer scenarios where the EOT is not a last-resort transaction. They look for independent trustees on the EOT board with a clear plan for the seller’s transition out of the business and continuity with the remaining management team.

Incentivising management

Incentivising remaining management is crucial and this requires careful planning, considering both the current and future roles and responsibilities of the individuals concerned.

Incentives can include share options and traditional performance-related bonuses. Additionally, employees can benefit from tax-free bonuses of up to £3,000 per year.

Risks when selling an employee ownership trust

There are risks associated with selling to an EOT which require careful navigation. For owner-managed businesses, conflict can arise where debt is owed to them. Bear in mind that the business will have to fund the value paid to the sellers (or repayment of new debt) through ongoing cash generation and this could take many years.

Furthermore, HMRC is increasingly focused on abuse of EOTs – the tax consequences of getting it wrong can be catastrophic.

We expect EOTs to continue to grow in popularity, becoming a more mainstream exit option. However, favourable tax treatment should not be the main driver – it must fit the ethos and culture of the business.

EOTs require careful planning, effective communication and a clear transition strategy to avoid potentially significant issues. Engaging with experienced advisers is therefore critical in maximising the chances of success.