A&M Tax Advisor Update
The employee ownership sector is going from strength to strength. The Financial Times recently reported that nearly 500 employee ownership trusts were created in the twelve months up until September 2022. This is up from 235 in the previous 12 months and 56 the year prior to that, as more business owners turn to this succession option.
In this article, we look at what an employee ownership trust (EOT) is, the benefits of selling into an EOT and what the future looks like for the sector.
What is a sale to an EOT?
A sale into an employee ownership trust (EOT) is a succession route for business owners to consider alongside options such as a trade sale or a sale to private equity. It allows company owners to sell more than 50 percent of their business to a trust for the benefit of their employees, free from capital gains tax.
The sale may be funded by free cash in the business, vendor finance or third-party debt.
The employees are not required to contribute capital to the business to receive the benefits of ownership, unlike in a partnership structure or management buy-out. After a post-completion period during which any vendor finance will be paid off from distributable profits of the business, free cash in the business may be applied for the benefit of the employees. The payment of benefits to employees is subject to certain safeguards, including to ensure benefits are applied on a broad all-employee basis. Controls may also be included to prevent the payment of windfall gains to employees.
What are the benefits of selling to an EOT?
There are many benefits of selling to an EOT:
From the selling owners’ perspective, a sale to an EOT enables the owners to preserve the legacy they have created and protect the culture and values of the business, ensuring these are not lost on a sale to a third party.
The sellers sell for market value, which should be established by an independent commercial valuation of the business. This is not a gift of the business to the employees.
An EOT exit provides a more certain exit for owners. Once the owners are happy with the structure of the transaction and the valuation, the sale can proceed without the risk of collapse. Execution certainty is commonly highlighted by business owners as a significant benefit of selling to an EOT.
At a time when taxes are increasing, dividends are taxable at up to around 40 percent and capital gains on the sale of shares at 20 percent (subject to business asset disposal relief if available), a sale to an EOT provides a zero percent tax rate for the sellers. Therefore, the sellers will keep the full payment that they receive.
From an employee perspective, employees become indirect owners of the business who may share in its future growth, success and wealth creation. Employees are aligned with the business and are incentivised to drive long-term value.
Many businesses which have transitioned to employee ownership describe that in the war for talent, employee ownership differentiates their business from non-employee-owned businesses.
There is also evidence that EO businesses are more resilient than non-employee-owned businesses during an economic downturn. Research shows that EO businesses are better at maintaining top-line performance and employment levels during recession. In relation to the impact of the pandemic, Scottish Enterprise have reported that a greater proportion of employee-owned companies experienced turnover growth or did not have their turnover affected by the pandemic compared to non-employee-owned businesses.
What does the future look like for the sector?
The sector has done a lot of work in the last few years to increase understanding in the advisory and financial community regarding the employee ownership trust model. The growing numbers of businesses transitioning into employee ownership show the success of this approach.
Other initiatives such as Ownership Hubs which raise awareness, knowledge and capacity to grow employee ownership are gaining traction, and most recently Sadiq Khan has announced the opening of a London Employee Ownership Hub in 2023.
In light of the benefits of the employee ownership trust as a succession option and the increasing evidence of the success of the model, the future looks to be bright for employee ownership.
How can A&M Taxand help?
The team at A&M Taxand has considerable experience in advising companies who are considering a sale to an EOT and would be happy to talk through the considerations of implementing an EOT with you and how we can help you structure a sale to an EOT. Please contact your A&M point of contact or Samantha Lenox or Louise Jenkins from our Reward & Employment Tax team.
1 “UK businesses turn to employee ownership at record rates” Financial Times 8 December 2022
2 Page 8 – “Does Employee Ownership Confer Long-Term Resilience” – January 14, 2014, Cass Business School and Newcastle Business School, Northumbria University, the Employee Ownership Association.”
3 Employee-owned businesses demonstrate resilience and boost the Scottish economy (scottish-enterprise-mediacentre.com)
4 The Ownership Hub | The Ownership Hub and Ownership Hub Archives | Employee Ownership Association