Business management

Employee ownership: how does it work in practice?

A growing number of company owners, including professional services, are considering the potential benefits of setting up employee ownership trusts.

Is a sale to an EOT an alternative to a standard trade sale?

“Yes, but the way in which the sale is structured, the period over which sale proceeds are received and the way in which they are taxed are very different.”

How does the EOT model work?

“The legislation that enables the formation of EOTs was passed by the coalition government in 2014 to encourage a more sustainable, responsible model for company ownership. It provides generous tax reliefs for shareholders who sell to an EOT, but the most important reason to sell to an EOT is the long-term benefits it can bring, to the shareholders, the company and its employees.

“The EOT structure is created when shareholders sell to the trust under a share purchase agreement. Some existing shareholders may become trustees, but EOT trustees are also often corporates. When the shares are sold this creates a debt owed by the EOT to the shareholders – a ‘deferred consideration’. From this point onwards, some of the company’s after-tax profits can be contributed to the EOT, which then repays the former shareholders’ deferred consideration in a series of payments over a longer period, typically six to eight years. Deferred consideration payments are exempt from capital gains tax (CGT). It is also possible to pay annual tax-free bonuses of up to £3,600 per year to employees of the EOT-owned company.”

Under what circumstances might a company’s shareholders consider selling to an EOT?

“The shareholders may wish to sell to derisk themselves, while not necessarily wanting to exit the business immediately. They may want to keep the business as a standalone entity for the benefit of the employees, while selling their stake in a tax-efficient way. Selling the business this way can also address succession issues in family businesses if younger family members do not want to take over the business.

“Selling to an EOT seems particularly well suited to ‘people’ businesses, such as professional services firms, where there is a strong culture and the idea of selling to a large conglomerate often won’t work for the shareholders or the business; and where much of the value of the business lies in its employees. The EOT model, which incentivises employees to commit themselves to the business for the longer term, can help safeguard the future of the business.

Research suggests that companies with an employee ownership structure are likely to be more resilient than other businesses when trading conditions are difficult

Matthew Emms
Partner, BDO

“EOTs can be used by businesses in many different sectors, including professional services firms such as accountants, lawyers or architects. Transactions we have worked on in recent months have included work with companies in construction, recruitment, consultancy and the food industry. Enterprise values involved have ranged from £4m up to £90m, and the number of employees from 15 to 600.

“I’ve also been approached by businesses operated via limited liability partnerships (LLPs), a model often used by professional services businesses. The EOT structure can be used by LLPs, but they will need to be incorporated, with the former members of the LLP then becoming shareholders who can sell their shares to the EOT.”

What are the most important potential advantages, for shareholders and employees, of moving to this type of ownership model?

“For many shareholders, the ability to sell their shares at full market value without having to pay CGT is very attractive. Shareholders can also choose whether to sell some or all of their shares, although the EOT must always own 51% or more of the company.

“Creating and selling to an EOT also creates an immediate purchaser for the business. The shareholders may have tried to sell the business through the usual channels, but found that a prospective acquirer was demanding onerous warranties or indemnities. With an EOT, because the trustees also tend to be shareholders, the shareholder agreement can be much more straightforward. Professional fees are also likely to be substantially lower.

“Staff tend to be more committed to a business when they have a stake in it. Provisions within the tax legislation also allow companies to put tax-efficient share plans in place to grant lock-in and incentivise key management, allowing them to acquire a substantial stake in the business in a tax-efficient way.

“Research from the Cass Business School suggests that companies with an employee ownership structure are likely to be more resilient than other businesses when trading conditions are difficult.”

What are the pitfalls that companies need to avoid as they move towards an EOT structure?

“It is important to remember that the value of the shareholders’ deferred consideration is set at the point of purchase. So if the company were to increase in value from the date of disposal, the former shareholders would not benefit from that upside.

“But if the company fails to make profits, the company may be unable to make payments to the EOT, which would restrict the payment of the deferred consideration, or extend the period over which it is received.

“Professional services firms should notify their registered industry body or regulator, such as the Solicitors Regulation Authority (SRA) for a solicitor’s firm, or the Financial Conduct Authority (FCA) for a corporate finance house, of the planned change in status.

“Shareholders must ensure the company meets all qualifying criteria for the EOT structure, and that the company is eligible for tax relief. If it is sitting on a lot of cash, it could be regarded as having a large amount of non-trading assets. Shareholders should also ensure that the deferred consideration will not be subject to anti-tax avoidance legislation. It may be necessary to obtain a clearance from HMRC to confirm this.

“I would definitely recommend that anyone seeking to do this take advice from someone with experience in this area to ensure all their commercial and personal objectives will be met when they move to an EOT structure.”

Do you expect to see more professional services firms adopting this type of structure in future?

“The Employee Ownership Association estimates that companies that are employee-owned, or where employees have significant ownership stakes, now contribute £60bn to the UK’s GDP. I anticipate this will continue to be a growing trend and that many more companies will move to this structure in future. This is now a mainstream option: an alternative to a standard trade sale that company owners should be considering.”

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