Sunday, July 3, 2022

Why are employee ownership trusts growing in popularity?

Debra Martin

Debra Martin, partner and head of the corporate team at Geldards LLP in the East Midlands, discusses the growing popularity of employee ownership trusts.

The use of employee ownership trusts (EOTs) to transfer ownerships of companies is becoming increasingly popular.

Originally launched in 2014 as a tax-efficient way of transferring ownership of a company, EOTs are designed to encourage a more ‘collegiate’ ownership model.

They are attractive to business owners as a way to pass on their companies outside of a normal “trade sale” to a competitor or a management buyout.

In the last year, the pandemic, combined with fears over potential changes to capital gains tax (which never happened), have led many business owners to re-evaluate their circumstances.

As a result, the use of EOTs is on the rise. As of last year, there were 470 employee-owned businesses in Britain, according to figures from the Employee Ownership Trust. While up to date figures are delayed because of the pandemic, the Trust believes the last year will be the biggest growth year yet.

And it’s no surprise EOTs are going mainstream – they are a hugely attractive proposition for many reasons.

So, what is an EOT? Basically, an EOT is a trust that has to own a controlling interest in the company in order to achieve the tax benefits for the selling shareholder and the staff.

If the relevant conditions are satisfied, the seller will pay no capital gains when they sell their shares, with no upper limit on the value. Also, employees can be paid an income tax-free bonus of up to £3,600 per year.

Often the key driver is that an EOT allows a company founder to protect their business legacy, to maintain the ethos of the business and their way of running things.

It also allows them to protect the jobs of their staff and keep the business in the same location.

None of these things are guaranteed if the business is sold to a third party.

The sale process is also much easier because the business is being sold to a trust on a ‘friendly’ basis – there’s less paperwork and the sale won’t go through months of due diligence.

There have been some great success stories here in the East Midlands.

For example, Pennine Healthcare in Derby, one of the UK’s largest suppliers of medical equipment to the NHS, recently transitioned to employee ownership.

The deal means the business and its 200-strong workforce will remain in the city. All employees with at least a year’s service will each have the opportunity to receive up to £3,600 in income tax-free dividends from the company’s annual net profits.

Despite the benefits of EOTs, it’s not necessarily an easy process and there can be practical difficulties to overcome – the main ones relating to funding and management.

When it comes to funding, the EOT has to be funded by someone to buy the shares. Banks might be reluctant to lend to an EOT trustee, so funding usually has to be directed via the company, which might not be able to service additional borrowing.

In terms of management, the business still requires a capable management team to take the company forward – management by committee vary rarely works.

So, an EOT can be a good solution for a company owner looking to retire and sell up when there is no obvious third-party buyer.

That is, of course, provided the company has the ability to fund an EOT either directly or via a third-party loan. In some cases, the exiting owner will have to compromise on what they think the business is worth.

In the example of Pennine Healthcare, the sale to an EOT was at the lower end of the business’ valuation, but it was important for the owners to keep the business and workforce local.

EOTs have proved to be attractive solutions for selling shareholders as well as the management and employees in “people critical” businesses. They are often driven by a desire to give back to the staff who have helped build the business and reward their loyalty.

This year is set to be a bumper year for EOTs in the East Midlands, as more business owners want to secure their legacies and pass their companies on to the people who helped make them successful.

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