Employee ownership trusts (EOTs) have been around for a few years; they provide an interesting and practical solution to a number of real-life challenges facing business owners, notably the challenges to effecting a successful trade sale of your business, whilst simultaneously rewarding, motivating and empowering employees. What are they, and how do they work? Jim Truscott, Partner and Head of the Corporate team, explains.
In a traditional trade sale, a process is undertaken involving extensive review of the target business by an intended buyer, followed by a negotiation of a transaction which is likely to involve some element of deferred consideration based on future performance of the company, and therefore some inherent uncertainty in relation to whether full value will ever be received. Additionally, and a key consideration for business owners – many of whom have nurtured their workforce and taken them on a journey from early beginnings of a business to its sale – a key question is how to ensure that your workforce properly receives a reward for its contribution to achieving this exit. Moreover, there is a challenge in ensuring the motivation of your workforce post-transaction and their commitment to continuing growth of the business you have created.
Solutions to these latter issues have involved a number of approaches in past years, including the issue of bonuses, shares or share options to key staff. However, the EOT model operates to provide a highly effective tool to satisfy a number of these challenges in a very tax-efficient and cost-effective manner.
What is an EOT?
An EOT is a trust which is established with a corporate entity (ie a trustee company) as trustee. The shareholders of the company being sold will transfer their shares to the trustee company on the basis of an agreed valuation. The purchase price payable for the sale of the shares creates a debt owed by the trustee company to the shareholders which is left outstanding. This debt is then repaid over time, using profits generated from the company and transferred to the trustee company.
Because the employees have an interest in the trust, they are effectively able to purchase the company from its shareholders without using their own cash. The buyer’s due diligence requirements will be limited, because this is akin to a management purchase – they are familiar with the company – and so generally the negotiation of the sale will be considerably more straightforward than would be the case on a trade sale to a third party. From the prospective of the selling shareholders, again the transaction process is cut considerably shorter than would otherwise be the case on an arm’s length sale, but moreover, no capital gains, inheritance tax or income tax liabilities should arise on the sale of the shares. It is not always the case that the sellers will sell the entirety of their stake, and commonly it will be the case that a majority owner-manager will use a structure like this to dispose of a substantial portion of their business whilst retaining control over its operations – all the while enabling a newly-incentivised workforce to step up to the next level and allow a full exit in due course.
Qualifying conditions
Various conditions must apply before a sale to an EOT can be undertaken, including that the company itself is a trading company. In practice, these conditions are generally straightforward to satisfy.
What sort of companies are using this structure?
The general appetite for effecting a sale transaction in the present climate – fuelled with concerns of impending capital gains tax increases in the context of the economic challenges posed by the Covid pandemic – means that many business owners are looking to accelerate a sale process. An EOT transaction, for the reasons outlined above, can be effected more speedily and with less overall transaction costs than may otherwise be the case on a normal trade sale. We are seeing EOT transactions effected across a number of sectors, including technology, manufacturing and professional services. The EOT structure can be used for companies ranging from those with very few employees to those with several thousand, and will no doubt continue to be a popular tool to create practical solutions to business owners’ concerns relating to employee engagement, the minimising of the tax burden and the wish to avoid protracted transaction processes.
We will be happy to discuss the whys and wherefores of an EOT structure with you from a practical perspective. Just get in touch, we’re here to help.
First published in Business Insider North West
