Employee ownership can be a highly effective business model. Employee ownership trusts (EOTs) offer a tax-efficient way for company shareholders or founders to transfer ownership to their employees whilst still being paid for their shares at market value. Whether your objective is to engage and empower your employees or to secure your legacy as part of a succession plan, employee ownership could be an excellent option for you. In this guide, we will explain what an EOT is, how to set one up, and how they work.
What is an EOT?
An EOT or employee ownership trust is a type of trust that enables employees to take ownership of their company. First introduced by the UK Government in 2014 as part of an initiative to encourage employee ownership, EOTs offer significant benefits for shareholders, employees and businesses.
Benefits for shareholders:
- Shareholders can sell their shares to an employee ownership trust at the full market rate, free from capital gains and inheritance tax.
- EOTs can be a highly effective and tax-efficient way to transfer company ownership to its employees, making them an excellent succession planning tool.
- Shareholders can keep up to 49% of the company’s shares after establishing an employee ownership trust, benefitting financially from any improved performance achieved through employee ownership.
Benefits for employees:
- Employees gain a stake in their business and can benefit financially depending on its performance, including annual tax-free bonuses of up to £3,600.
- An EOT gives employees greater control over their company’s leadership and direction through its appointed trustees.
- Employee ownership often leads to improved motivation, engagement, job satisfaction and morale.
Benefits for companies:
- In most cases, happier and more engaged employees will be more productive and stay longer, boosting business performance and retention.
- Employee ownership often results in better alignment between a company and its employees, alongside increased innovation at all levels, as employees feel they have more of a stake in performance.
- Employee bonuses paid by the EOT are deductible from corporation tax.
How does an EOT work?
With an employee ownership trust, the trust owns company shares on behalf of employees rather than them owning the shares themselves. Trustees are appointed to manage the trust, represent the employees’ best interests, and ensure management runs the company effectively. These trustees can include a variety of stakeholders, such as directors, shareholders, employees, or independent external parties, including solicitors, accountants or professional trustees.
In many cases, particularly when creating an EOT as part of a succession plan, previous business owners will become trustees after establishing the EOT to ensure a smooth transition and share their expertise and experience with the management team.
Alongside trustees, companies owned by an EOT might appoint an employee council. Unlike trustees, members of the employee council are elected from the trust’s beneficiaries, usually employees.
How to set up an employee ownership trust
You can set up an employee ownership trust at any point, and with the right legal advice and guidance, the process can be relatively straightforward:
- Establish the trust: when setting up an EOT, the first step is for your solicitor to create an appropriate trust deed. This complex legal document establishes the trust, detailing its beneficiaries, trustees, terms, and property, alongside setting out how the trustees must manage the trust and its shares.
- Purchase shares: the employee ownership trust must purchase at least 51% of the company’s shares from its existing shareholders. Solicitors will negotiate and prepare appropriate share purchase agreement and various ancillary documents to do this. If the trust lacks the cash reserves (provided by the company) to buy the shares outright, it must find an alternative way to fund the trust. Options could include external finance, deferring payments to the existing shareholders, or a combination of both. We explore how to fund an employee ownership trust in more detail later in this guide.
- Repay shareholders: if the shareholders agree to defer payments, the EOT must make payments from future company profits. This arrangement should be set out in the share purchase agreement.
How is an employee ownership trust funded?
Employee ownership trusts can fund the purchase of shares in a variety of ways:
- Surplus cash: if a company’s cash reserves are large enough to pay for the shares upfront, it can make a contribution to the EOT to fund the purchase. Whilst this is the simplest option, companies rarely have the cash available.
- Deferred consideration: existing shareholders can agree to defer payments, known as deferred consideration, enabling the trust to repay the purchase from the company’s future profits.
- External finance: EOTs can seek external finance to fund the purchase of shares. Securing external finance for an EOT can be challenging, and expert advice may be required.
- Combining deferred payments and external finance: in some cases, shareholders may agree to defer a percentage of the payment price. In this case, an EOT can seek external finance to cover the remaining cost.
What happens when an employee leaves an EOT?
If an employee leaves an EOT, they are simply no longer a beneficiary and will not get a share of future profits or have a say in how the trust operates.
Can an EOT be sold or sell its shares?
Whilst an EOT cannot be sold, it can sell its shares. However, this rarely happens as a sale must be in the best interest of the trust’s beneficiaries, the company’s employees. If the trust does sell its shares, it must pay any deferred consideration and will incur capital gains tax if it has profited from the sale of shares. The trust must distribute the remaining proceeds to the trust’s beneficiaries as a cash bonus.
Whether you are considering an employee ownership trust as part of your succession plan or need reliable legal advice on managing your trust, Scott Bailey’s expert company and commercial solicitors can help. With extensive experience supporting SME businesses, our highly skilled team will provide you with legal advice you can trust and guide you through the process. Contact Scott Bailey today to get started.
