The last few years have seen a dramatic increase in the number of businesses owned by Employee Ownership Trusts (EOTs), to the point where there are now 576 employee-owned businesses in the UK.
Many are now benefiting from all the good things that stem from a business becoming owned by its employees, which include:
- A relatively undisruptive sale process
- A tax efficient sale for the original owner
- Goal congruence for all those involved in the business
- Stronger performance generally, and
- Employee incentivisation and retention
But many business owners are now reaching that point in their lifecycle where a third-party offer for the business has either been received or is being contemplated. Having worked on a transaction involving the sale of a business by an employee share ownership, it’s apparent that the experience and analysis going in is better developed on the other side.
Is a sale the right thing?
What becomes clear very quickly in the deal process is that Employee Ownership Trusts were not designed as vehicles for onward sales. They work wholly on the principle that they are for the benefit of all eligible employees on the same terms and, while you are “on that bus”, you can participate in tax-free bonuses and dividends. If an employee leaves employment, then the bus simply carries on its way.
Trustee responsibilities
Being a trustee is an onerous responsibility at the best of times, but trustees of EOTs are tasked also with ensuring that they’re always acting in the best interest of the employees.
If an onward sale is contemplated, then this will require separate legal advice and transaction support to ensure that the right decision is made – and is seen to be made.
Trustee conflict
There are many EOT structures where ownership is greater than 51% but less than 100%. This is where the original shareholder has retained shares while also acting as a trustee of the EOT.
How do you manage this potential conflict and ensure that the trustee/shareholder has the right hat on at the right time?
Capital Gains Tax
Most capital transactions see an automatic uplift in the base cost of the shares. What you pay for your shares becomes your base cost for a future transaction.
This is not the case for EOTs – the relief from Capital Gains Tax (CGT) for the original vendor results in the EOT picking up his or her original base cost and, as such, will see the trustees liable to CGT at the rate of 20% on the full value now being received. There are ways around this, but it’s not straightforward.
Income Tax
Distributions to employees upon a disposal are taxed income tax as being by virtue of their employment and, as such, suffer both PAYE and National Insurance. Add all these taxes up, and you quite quickly get to a pretty punitive tax rate.
Yes, I know that the employees never had to pay for the shares in the first place physically but try telling that to an employee who may well be suffering tax at a rate as high as 60%!
Employee communication
As it’s all relatively complex and difficult to understand, employee communication and support throughout the process are key. Corporate Finance deals are generally time pressured and fraught with the normal ebbs and flows of a deal process, but you need to ensure that the employees are engaged and come with you through that process.
If you need any advice on Employee Ownership Trusts, get in touch with BHP Corporate Finance at 0333 123 8181.
