Employee Ownership Trusts (EOT)
With the number of employee ownership trusts more than doubling in the last three years and breaking the 1500 milestone this year, Tom Lethaby from RVE Corporate Finance explains how they work and the potential pros and cons.
Employee ownership trusts (EOTs) are becoming increasingly popular, with the numbers having increased significantly over the last few years. High-profile examples of businesses with an EOT structure include Go Ape, TTP Group, Richer Sounds, Riverford Organic Farmers and Aardman Animations, the creators of Wallace and Gromit.
EOTs are a particularly useful tool for company owners looking to wind down their day-to-day involvement in their business in a tax-efficient way. However, they also have major benefits for the company’s employees.
An EOT is, as the name suggests, a trust established for the benefit of a business’s employees. The trustee of the EOT is normally a company limited by guarantee. The business is sold by its owner to the EOT and the EOT then owns the company, whose own directors normally retain day-to-day control of the company’s affairs.
Basics
When a business owner sells to an EOT, they receive (up to) the fair market value for their shares in the target company, as determined by an independent valuation. It is important to note that there is no need for the business owner to sell at a discount compared to the price they might have received in a trade sale.
The consideration for the sale is normally in the form of cash and loan notes. The EOT typically funds the consideration from any surplus cash available in the target company at completion and then from the ongoing profits of the business. The terms of the loan notes are normally flexible to allow for fluctuations in the company’s performance post-completion.
The current rules around EOTs were created with a view to actively encouraging employee ownership, following the recommendations of the Nuttall Review in 2012. There are, accordingly, generous tax breaks for business owners selling to EOTs, including, if certain qualifying criteria are met, a 0% rate of capital gains tax (CGT) on all of the gain arising from a sale of shares to an EOT. This compares very favourably to the 20% CGT rate that would otherwise be payable (or 10% if Business Asset Disposal Relief is available, capped at the first £1m of gain).
There are also tax advantages for the employees of the target company, such as a limited exemption from income tax on bonus payments of up to £3,600 per year.
To take advantage of the relevant tax legislation, advance clearance from HMRC is recommended through the statutory ‘Transaction in Securities’ clearance procedure.
Most EOT sales have so far been for small businesses, typically worth less than £20m, and an EOT can be appropriate for businesses worth just £1m to £2m. It can be used for much larger businesses, however, with the largest EOT deal so far being for a company worth £275m.
Ongoing governance
Once the sale has completed, not much changes in the target company from a legal perspective. The employees remain employed by the same entity and the company carries on trading largely as before. Very often the directors of the company will also not change immediately. The change in shareholding does, however, result in noticeable changes in the governance of the company.
A key change is that decisions at a shareholder level will now be taken by the trustee rather than the seller. It is important that the board of the trustee company properly represents the employees as well as having members with suitable expertise in company governance. As a result, the directors of the trustee company commonly comprise a mix of employees, independent professionals and perhaps also the original seller (at least until they are paid out).
While not strictly required from a legal perspective, in practice the trustee will normally be more of a passive shareholder than an individual owner would be. The trustee’s main role will be overseeing the profit-share policy and loan-note payments and reviewing the trading company’s financial performance. The trading company’s board typically remains responsible for strategy and operational matters. However, the trustee does have control over the appointment and dismissal of the trading company’s directors and their remuneration, so it is a role with some teeth if those directors do not perform.
Is it right for your business?
Sale to an EOT will not suit every business. However, we strongly feel this is something which all business owners should consider when planning succession.
About author Tom Lethaby is part of the team at RVE and is the Independent Chairman of 8 companies that have been sold to an EOT. RVE are a corporate finance advisory firm that advises business owners on their exits, with a focus on EOTs. They provide integrated financial, tax and legal advice to structure and execute EOT transactions. They have advised over 30 companies on their transition into employee ownership in the last three years across a range of business sectors, ranging in size from £1m through to possibly the largest EOT transaction to date (£275m). RVE is an advisory member of the Employee Ownership Association and a member of the ICAEW Corporate Finance Faculty. |
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