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Employee Ownership Trusts - How to Sell your company Tax Efficiency

What is an Employee Ownership Trust?

In the Finance Act 2014, Employee Ownership Trusts (EOTs) were launched. The EOT provides employees a direct stake in their futures and can lead to increased productivity and creativity at work.. Employees who work in a positive, collaborative environment are more engaged and committed. If the firm is sold in the future, qualifying employees will share in the sale proceeds.

The Employee Ownership Trust structure explained

  1. The Employee Ownership Trust (EOT) gets money from a third-party lender via the promise of a company guarantee (senior or subordinated debt) and/or enters vendor loan agreements.
  2. Third-party lender/vendor may take possession of the company’s assets (a charge) rather than simply the debts; third-party lenders can also seize control of shares.
  3. The firm makes donations to the EOT in order to meet its obligations to third-party and vendor creditors.
  4. Over time, the EOT’s contributions from distributable reserves, third-party and/or vendor loans are paid down in parts.
  5. Vendors may sell all or part of their shares to the EOT for cash (excess cash and/or third-party loan proceeds) and vendor loans, which are not subject to capital gains tax in the year the EOT gets a controlling interest.
  6. To fund purchases, the EOT draws on company cash, third-party finance, or vendor loans.
  7. Bonuses paid to staff are tax free, up to £3,600 per person each year.
  8. The company may provide shares or options to key managers and employees as a group as an incentive to align interests, not a must.
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Why might you want to use EOTs?

  • Are you thinking about selling your firm in order to gain some cash?
  • Do you wish to retire and sell your company to its own employees?
  • Perhaps you’d want to restructure your business in a more tax advantageous

Many businesses, both large and tiny, have benefitted from selling to an Employee Ownership Trust. Our knowledgeable staff has worked with restaurants, factories, and electrical contractors, among other industries. A growing number of company owners are considering the advantages of establishing an Employee Ownership Trust in the areas of fashion and music, as well as healthcare and publishing companies.

Is an Employee Ownership Trust right for your company?

This popular business structure has advantages for both the company owner and the employee. These benefits include no tax for the vendor and a sense of inclusion for the employee.

Advantages of an Employee Ownership Trust (EOT) for the vendor

  • The firm is still run independently, and vendors can leave an impression by building a long-term legacy.
  • The Time to complete a sale is typically less than third-party sales. For example, third party sale will take 9-12 months, A EOR takes as little as 8-12 weeks.
  • Transaction expenses are typically far lower.
  • Vendors sell at market value with greater confidence in completion, since they are in command of the key elements of the deal.
  • There is no need to interact with third-party purchasers. In addition, the vendor does not have to share information with rivals.
  • Regarding attracting and keeping critical staff, it may provide a competitive edge.
  • An EOT is not subject to CGT (Capital Gains Tax) if it purchases a controlling interest in a firm.
  • As of April 2020, the Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief Allowance) has been reduced from £10,000,000 to £1,000,000.
  • Excess funds may be paid out to the vendors in tax-free equity value.

How do you fund a Employee Ownership Trust (EOT) business purchase?

  • Cash or Retained Profits on the balance sheet
  • With a vendor loans, the EOT trustees borrow money from the vendor with a corporate guarantee. The loan is paid back to the vendor over an agreed period.
  • With a bank loan – The trustees borrow money from the bank.

What is the company worth?

The trustees of the EOT must come to an agreement on the price of the company. A professional share valuation may be required.

Because there is no tax to pay for the vendor, EOT’s are extremely tax efficient.

It could usually result in one of two things:

  1. Better valuation for the Business owners, or
  2. The vendor may provide a lower purchase price while still getting the same net return because of the tax difference, which might be significant.

It’s critical to have a professional assessment when creating the trust and transferring ownership.

It must have the valuation from an independent expert that defends the price and the EOT trustees have trust in. The valuers’ aim is not to provide a range of values based on particular conditions or circumstances; instead, they must agree on a valuation that they believe reflects true market value and may be used by the trustees and justified before HMRC.

If the valuation is too high, HMRC may consider that the EOT has paid an excessive amount for a company. The extra amount will be taxed as income tax rates. While the valuation of the company should be comparable to that of a trade sale, in most cases, it’s normal that the payment terms for the consideration by an EOT will be over a much longer period, than would be normal from a trade sale.


What are the criteria for establishing an EOT?

It is worth noting the following if you are considering whether an Employee Ownership Trust is appropriate for your company:

  • Your current organization should be a trading firm or a subsidiary of one.
  • All workers must benefit from the program and be treated equally.
  • At all times, the trust must own half of the company’s capital.
  • An EOT structure may be used by a new company.
  • They can also be used with EMI alternatives or other tax-advantaged share programs.

Who can be a beneficiary?

All employees can be beneficiaries of the trust, subject to a few restrictions set forth by the EOT legislation, which are:

  • Before becoming a beneficiary of the EOT. Employees must have been with the firm for a certain length of time. The shortest continuous term is up to 12 months;
  • Employees’ relatives or dependants may apply to become a beneficiary if the employee has died.
  • Non-executive directors and freelance company secretaries can also be beneficiaries; (this does not apply to contractors or agency workers, as they must be on the payroll in order to benefit);
  • “Excluded participants” cannot be beneficiaries. Excluded participants is anybody who has a stake of 5% or more in the company’s share capital and is connected with such person.

Are you able to complete a Management Buy-Out (MBO) with this arrangement?

While the rules surrounding structuring an EOT are tight, MBO rules are more flexible, thus making it possible for the two to work together to create a planned retirement plan for current owners.

The existing management team might buy a 10%, 20% or even 30% interest in the company. With the option to purchase more shares over time up to a maximum of 49%, and have 51% equity ownership in the hands of employees with an EOT. Given their position, the existing management team is likely to be trustees and beneficiaries of the EOT (unless their personal stake in the MBO exceeds 5% of total equity), demonstrating their support for the handover of control that is necessary as part of an MBO.

By taking the technique outlined above, transferring ownership should minimize the upheaval that a sales transaction would typically cause for a business. The current owners will gradually hand overall control and management of the company to the incumbents. If the EOT is already in place and the present management team acts as trustees, little will change in terms of the Board’s structure. Even if there isn’t a pre-existing EOT, there’s no reason they can’t be set up in parallel to minimize business disruption than a more conventional private equity-backed MBO. From a workplace culture standpoint, the two being set up together may have a beneficial influence on the company’s entire workforce since they will be involved in the business’s total sale and feel connected to the company’s next stage. It is possible for the vendors to complete a change of ownership as outlined above, but they must take care to structure it carefully and that any consideration paid to them, especially with delayed payment, is solely that and not employment-related pay. It’s also worth noting that the management team members who sold shares as part of the MBO would profit from share buybacks at the time of exit in the future. The second worry is that, while EOTs introduce employee ownership in a business and not individuals, the profits on their investments are only realized by those in the company at the time of exit (beyond the tax-free, annual bonus that employees may receive). For those persons who have little or no prior understanding of company ownership and capital value growth, this may perplex; the technique is intended to encourage loyalty and extended service in the firm.

The company may also need to get a double tax clearance, as both an EOT and an MBO necessitate the filing of an application with HMRC.