Employee Ownership Trusts: Looking to employees to continue the legacy

Employee Ownership Trusts: Looking to employees to continue the legacy

All business owners need a succession plan. For many the obvious route would seem to be that of a trade sale, however depending on the culture of the business, the presence in the local region and the owner’s thoughts about their legacy, looking to their employees to take on the ownership can be a valid consideration.

Employee ownership and employee ownership trusts

Employee ownership is a form of company ownership where a company is owned by its employees. Commonly this is via an employee ownership trust (an “EOT”), a relatively new arrangement introduced in 2014. An EOT is simply a trust set up for the benefit of all employees of a company. It is important to note that all of the employees have to benefit broadly equally from the trust.

Do I give away my company to the employees?

No, the creation of an EOT allows the current owner to sell their company to the EOT for a fair market value. It can be an attractive proposition as tax breaks were introduced in the 2014 legislation that make the sale of a company to an EOT free from capital gains tax. However, the motivation to undertake an EOT should not be driven purely by tax incentives.

How does the EOT pay for my company?

Typically, the EOT would pay for the company in a similar way to a self-funded management buy-out. However, there needs to be a degree of patience on the vendor’s side in receiving any cash consideration. While any surplus cash in the company is paid out to the vendor, the balance of the purchase price is typically paid for over time on deferred terms as the company generates future profits rather than by increased debt borrowing.

How much would the employees pay?

The price payable is a fair market value for the company. This will reflect the intrinsic value of the company as it stands. It is possible a trade buyer or private equity investor looking to consolidate or make substantial additional equity investments into the business may be willing to pay more because of the synergies they might be able to achieve leveraging other business or investments that they hold. However, for many sellers the purchase price is not the only consideration; achieving a good price but with the knowledge that the sale will not lead to substantial job losses and a hollowing out of the business that they have spent half a lifetime building is more important than squeezing out every last penny.

The tax is good, but is it commercial?

Many successful businesses do not have controlling shareholder-managers. These include many later generation “family” owned businesses and listed companies. While the employees own shares collectively, no one employee holds shares. However, it does not mean decision-making by committee. The company still has a board of directors and those directors make the operational decisions for an employee owned company in the same way as for any other company. The non-money motivations for good performance can also often be emphasised by an employee owned businesses with a common vision and sense of purpose created by the employees in the business collectively. For example, the top 50 employee owned businesses in the UK saw mean productivity increases of 6.9% in 2020. That is not to say it is easy, it takes work and the culture of the organisation plays a large part.

So should I consider it?

It is well suited to successful mature businesses or ones where continuity and legacy are important considerations. The social and philosophical benefits to the business, its employees and its external reputation can be a key driver for a business owner, rather than just the tax benefits. This mechanism for the sale of a business may be particularly relevant and beneficial in light of the COVID-19 pandemic. EOTs may provide an alternative to where a business has been unable to attract a viable buyer. If you are considering your succession plans, then we believe employee ownership is well worthwhile reviewing alongside trade sales and management buy outs.