A guide to Employee Ownership Trusts

An Employee Ownership Trust (EOT) is a specific type of Employee Benefit Trust (EBT) designed to facilitate the transfer of a company’s ownership to its employees.

EOTs emerged as an important model for business succession planning, offering a mutually beneficial arrangement for owners, employees, and the company itself. This innovative approach not only facilitates a smoother transition of ownership but also aligns the interests of employees with the long-term success of the business.

What is an Employee Ownership Trust?

EOTs are designed to encourage employee ownership, allowing business owners to sell their shares to a trust owned by employees without incurring capital gains tax.

Instead of direct share ownership, a controlling interest in the company is transferred to an all-employee trust, with the shares held for their benefit.

How does an Employee Ownership Trust work?

An EOT operates under a structure designed to transition the ownership of a company to its employees without them needing to directly purchase shares. Here’s how it typically works:

Establishment of the trust

A trust is set up for the specific purpose of holding shares on behalf of the company’s employees. This trust is governed by trustees, who can include representatives from the company’s directors, employees’ representatives, and sometimes an independent trustee. Their role is to oversee the trust and act in the best interests of the beneficiaries (the employees).

Sale of shares

The current owner(s) of the company sell a majority, if not all, of their shares to the EOT. This sale can be at market value and, under the right conditions, the seller(s) can benefit from significant tax advantages, such as exemption from capital gains tax.

Control transfer

Although the shares are transferred to the trust, the day-to-day operations of the company are typically still managed by the existing leadership team. However, strategic decisions may now involve consultation with or approval by the trustees, ensuring decisions align with employee interests.

Once the shares are in the trust, the employees indirectly own the company through the EOT. This ownership gives them a stake in the company’s success and can lead to increased employee engagement and motivation.

Benefit to employees

Employees do not directly own the shares; instead, they are beneficiaries of the trust. They can receive benefits such as annual bonuses or profit shares, which are distributed tax-efficiently within certain limits. This setup aims to motivate and reward employees without the administrative complexity of individual share ownership.

Funding the purchase

The EOT can purchase the shares through an initial payment to the seller(s), funded from company reserves or borrowing, followed by further payments over time from the profits generated by the company. This allows the transition to employee ownership without requiring employees to personally buy the shares.

Governance

Trustees have a fiduciary duty to act in the best interest of the beneficiaries (the employees). They oversee the trust’s operation and the company’s governance structure, ensuring it operates for the benefit of its employees.

Employee involvement

While the trust legally owns the shares, employees often have a say in the company through various forms of engagement and representation, promoting a culture of ownership and participation.

The EOT model is particularly appealing for owners looking to retire or exit their business while preserving its legacy and ethos, ensuring job security for employees, and maintaining the business’s independence. It also aims to enhance employee engagement and productivity through shared ownership and the collective success of the business.

Who owns an Employee Ownership Trust?

In an EOT, the trust itself legally owns the shares of the company on behalf of the employees. The ownership of the trust is vested in the trustees, who are responsible for managing the trust and its assets in the best interests of the beneficiaries – the employees. Despite the trustees holding legal title, the beneficiaries (employees) are the ultimate owners in a beneficial sense. This means they are entitled to receive the benefits of ownership, such as dividends or proceeds from the sale of shares, as well as participating in the governance and decision-making processes through mechanisms established within the trust structure.

How is an Employee Ownership Trust funded?

An EOT is typically funded through the purchase of company shares from the selling owner(s). The funding for this purchase can come from various sources:

Initial payment

The initial purchase of shares by the EOT from the selling owner(s) may be funded through a combination of cash reserves held by the company, external financing such as bank loans, or seller financing arrangements.

Deferred payments

In some cases, the purchase of shares by the EOT may be structured with deferred payments, where the trust agrees to pay the seller over a period of time from the future profits generated by the company.

Profit shares

As the company continues to operate, it generates profits. A portion of these profits can be allocated to fund ongoing payments to the selling owner(s) for the shares acquired by the EOT.

Employee contributions

While employees do not directly fund the EOT, they may indirectly contribute through increased productivity and profitability, which in turn supports the financial health of the company and the ability of the EOT to make payments to the selling owner(s).

Overall, the funding for an EOT purchase is typically a combination of upfront payments, deferred payments, and ongoing payments funded by the company’s profits. This allows for a gradual transition of ownership to the employees without requiring them to provide significant upfront capital.

Setting up an EOT

The following critical considerations must be addressed when setting up an EOT:

Company structure:

Ensure your company structure is suitable for an EOT. Typically, private limited companies are most suitable, as they allow for the sale of shares to a trust.

Trust deed and documentation:

Draft a trust deed that outlines the objectives and terms of the EOT, including how shares will be held and managed for the benefit of employees. Additionally, all necessary legal documents needs to be prepared, including resolutions of the company’s shareholders and directors approving the establishment of the EOT.

Valuation of shares:

Determining the market value of shares that the trustee must acquire to gain a controlling interest in the company is essential. Independent expert valuation advice may be necessary to ensure fairness and compliance with regulatory requirements.

This stage is critical for setting a fair and realistic price for the sale, ensuring that the transition is feasible and beneficial for all parties involved.

Following the valuation, the next step involves structuring the EOT to suit the specific needs of the business. This includes determining the percentage of shares to be transferred to the trust and outlining the governance model that will guide the company moving forward.

Funding the acquisition:

The EOT can fund the purchase of shares through various means, including using company profits, shareholder loans, or external financing, or a combination of both. How this funding is secured, including any debt financing, and how any incurred debts and interest will be managed need careful planning.

This phase is crucial for ensuring that the financial arrangements are sustainable and align with the long-term objectives of the employee-owned business.

Trustee selection:

Careful consideration is needed regarding who will act as the trustee(s) of the EOT. There’s a potential conflict of interest if an employee or director of the company also serves as a trustee. It’s possible to appoint an independent trustee, but there are regulatory considerations, especially in light of recent government consultations aimed at ensuring independence from former owners.

Implementation of transfer

Execute the transfer of shares from the selling owners(s) to the EOT, including assessing what other legal documentation required in the specific situation.

Governance structure:

Establishing a clear governance structure is crucial. This may involve setting up an employee council to manage conflicts of interest effectively and ensure fair representation of employee interests within the company’s decision-making processes.

The establishment of the EOT need be communicated to employees, outlining their rights and benefits as beneficiaries of the trust. Thereafter, put mechanisms in place for ongoing reporting and governance, including trustee meetings and financial reporting.

Additional considerations:

• Notify HM Revenue & Customs (HMRC) about the establishment of the EOT, especially to benefit from tax advantages associated with EOTs; and
• Consider mechanisms for employee representation and involvement in decision-making processes within the company.

Setting up an EOT can be complex and requires careful planning and execution. Engaging with Moore Barlow and tax consultants is crucial to ensure a smooth and compliant process.

The benefits of EOTs

Enhancing employee engagement and productivity

The core advantage of transitioning to an EOT model lies in the significant boost in employee engagement and productivity. By having a stake in the business, employees are more likely to be invested in the company’s success, driving performance to new heights.

Tax efficiency

One of the most compelling incentives for adopting an EOT structure is the tax efficiency it offers. Sellers are entitled to certain tax reliefs, making it a financially attractive exit strategy. Disposals into the trust can be made free from capital gains tax and inheritance tax. Additionally, companies operating under an EOT can pay bonuses to employees (free of income tax), up to a generous annual limit, fostering a culture of shared success. Lastly, a corporation tax deduction for the value of the bonuses will be available to the company.

The impact of EOTs on business performance

A growing body of evidence supports the assertion that employee-owned companies tend to outperform their counterparts. The alignment of employee interests with company success leads to higher levels of innovation, customer satisfaction, and resilience in challenging economic climates.

The future of employee ownership

As the landscape of business ownership continues to evolve, EOTs stand out as a forward-thinking solution that benefits everyone involved. By embracing this model, companies can secure their legacy, empower their employees, and embark on a path of sustained growth and innovation.

How Moore Barlow can help

At Moore Barlow we provide unparalleled legal guidance and support to businesses considering the shift towards employee ownership. We can draft the required share transfer and trust documentation to ensure compliance with the law, work with your accountants enabling the beneficial tax treatment and providing assurance to the trustees that they are fulfilling their responsibilities appropriately.

Talk to our Employee Ownership Trust solicitors to discuss how we can help you. We are committed to navigating you through the complexities of EOTs, ensuring a smooth transition that benefits both business owners and employees alike.