Have you considered Employee Owned Trusts for your business exit?

The last 20 months have been tough. Whilst many people and businesses have been very resilient and adapted to “the new normal” well, there is an undercurrent of change in the air currently.

Covid-19 has prompted many people to re-evaluate whether they can realistically continue to work the way they used to pre-pandemic, or whether now is the time to take a step back and improve their work-life balance.

As a business owner, it is not always that simple to step back – you have a business to run, with employees, customers and suppliers who depend on you.  And traditionally, taking a step back would involve selling your company; a traditional sales process to a third party or an investment house is rarely an easy process and unlikely to reduce your stress levels.

However, have you considered selling your business to your employees? This can have multiple benefits, it can retain and motivate your key employees, reward the whole of your team whilst providing significant tax benefits for you. Furthermore, depending on your wishes, the process can be financed by the company and so avoids the need for external borrowing. 

Benefits for you as a shareholder

A sale to an Employee Owned Trust (EOT) is a “friendly disposal”. The friendly nature of the sale reduces the need for due diligence and ultimately speeds up the sale process compared with a traditional sale. Many find that the process of selling their shares to an EOT is less exhausting and less time consuming than a traditional sale to a third party.

In many management buy-out situations, the company needs to find external finance in order to fund payments to the departing shareholders – this is not always ideal, as too much debt can leave the company struggling to service the repayments. Where the purchase is made by an EOT, there is no need for external finance as the trust will leave the consideration to the selling shareholders outstanding. The consideration will gradually be repaid to the shareholders as and when the company makes profits which can be contributed to the trust. Alternatively, the trust could borrow the money from a bank, but this adds complexity if the aim is to keep the plan simple.   

It is not necessary to sell an entire shareholding to an EOT. This means that shareholders have the option to remain as involved in the business as they wish, although they should bear in mind that they will no longer have control of the company.

In addition to the reduced stress in comparison with a third-party sale, a sale to an EOT also brings with it some tax benefits. The main tax benefit for the selling shareholders is that no capital gains tax arises when they sell their shares to a qualifying EOT. This benefit may be even more relevant with the recent reduction in the lifetime limit for business asset disposal relief meaning that the capital gains arising on the sale of company shares in excess of a £1m lifetime limit will be taxable at 20% where the EOT provisions do not apply.

However, some sellers may find that benefit of the tax-free EOT gain is outweighed by accepting a lower price for their shares than if they were to sell to a third party.

How can an EOT motivate employees?

A company whose shares are held by an EOT can set up a tax-efficient bonus scheme that can pay up to £3,600 each year to employees, completely free of income tax. This is an efficient way of rewarding employees whilst enabling them to keep more of the bonus paid to them. Contrast this with a normal bonus which would be subject to income tax at up to 45%.

As the employees will be beneficiaries of the EOT, if there is a future sale of the company the trustees can distribute these sale proceeds to the employees. The benefit of this is two-fold. Firstly, senior employees are motivated to drive forward and grow the business in order to increase the share value, increasing the proceeds they receive as a result. The trust or company may be able to grant certain types of share options to beneficiaries to potentially obtain capital treatment for the ultimate disposal proceeds in the future but this will depend on the facts.

Secondly, the employees are motivated to remain employed by the business so that they can participate in the proceeds on future disposal; they would lose this right if they left employment to work elsewhere.

Conditions to be met

There are various conditions that must be met and continue to be met in order to qualify for the beneficial tax treatment given to EOTs.

The company whose shares are being sold must be a trading company or the holding company of a trading group.

The trust must acquire more than 50% of the company’s ordinary share capital. These shares must entitle the trust to more than 50% of the company’s voting rights and profits available for distribution. 

The trust must be for the benefit of all eligible employees.

All employees must be eligible to participate in the bonus scheme, although different bonus amounts can be paid to employees based on factors such as remuneration or length of service.

Conclusion

If you are looking to reduce the level of your involvement in your business but do not like the idea of selling to a third party, you may want to consider an EOT as an option that will allow you to step back without the need to reduce your involvement in the business entirely. 

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