Pros and cons of employee ownership trusts (EOTs)
Employee ownership trusts (EOTs) are relatively new in the business world.
However, they’ve had a recent surge in popularity. The results from a recent freedom of information request show that nearly 500 employee ownership companies were set up in the year ending September 2022. That’s up substantially from the 235 established in the previous 12 months and 56 in the 12-month period before that.
Accounting firm, Price Bailey, submitted the FOI request. Simon Blake, who is a partner at the firm, said that a difficult funding environment makes the option of selling to employees with tax incentives more attractive, as reported in Financial Times.
The most recent Employee Ownership Association statistics show that 181, 213 staff members collectively are part of an employee ownership trust.
It’s a popular model in the professional services (38.2 per cent), construction (13.2 per cent) and manufacturing (12.8 per cent) sectors.
We’ll explain just what an employee ownership trust is and the pros and cons of transitioning to this model.
What is an employee ownership trust?
An employee ownership trust is a specialist form of an employee benefit trust, introduced by the government in 2014.
With an employee ownership trust, shareholders are encouraged to sell their shares into a trust which is held on behalf of the employees of a company. It’s more common in business succession strategies but can also be used if a business wants to scale-up or change its structure.
John Lewis led the way on employee ownership in the UK and now has over £11.7bn and a workforce of over 80,000 ‘partners’. Well-known companies who have taken on an employee ownership trust include Aardman, richer sounds and Riverfords.
What conditions do I need to know to move to this model?
To open an employee ownership trust, you need to meet the following criteria:
- The company whose shares are transferred must be a trading company or the main company of a trading group
- All employees must benefit from the EOT. However, this excludes any employees in the business who already holds five per cent or more of the share capital in the business at the time the trust is set up, who cannot benefit from the scheme.
- The trustees must retain, on an ongoing basis, at least a 50 per cent controlling interest in the company.
The tax reliefs are subject to these conditions, especially the 50 per cent controlling ownership.
In fact, many of these are ongoing conditions; disqualifying conditions can be:
- The company stopping trade
- The EOT failing to meet all of the employee benefit requirements or controlling interest requirements
- A breach of the limited participation requirement
- The trustees not following the rule of equality
Pros of employee ownership trusts
There are plenty of benefits for the business owners, shareholders and staff.
If they have greater involvement in the business, employees will be more motivated and innovative
“There is a mental change that happens when you own something,” said Deb Oxley, CEO of the Employee Ownership Association. “It drives behaviours that relate to what needs to be done rather than what you want to do. It is this shift that helps to drive success in an employee owned business.”
As employees are more heavily involved, it’s shown to reduce absenteeism too.
Tax-free bonuses for employees
Companies co-owned by EOTs are also able to pay tax-free cash bonuses to their employees of up to £3,600 per employee per year.
Higher staff retention – and attracting staff
If staff have a greater personal investment in the business, they’ll stick around for longer. What’s more, it’s an appealing perk to place on your job adverts to attract staff.
Co-owned companies can be more successful, profitable and sustainable
As they play a bigger part in the business, staff become more entrepreneurial and want to contribute to the company’s success. It’s also a way of rewarding employees that have been loyal to the business and contributed to its success.
The business owner can still be on the board if they haven’t sold all of their shares, passing on the culture and values of the business before they leave it altogether. “This makes employees custodians of the business for future generations, making decisions and investment over the longer term, meaning the jobs and growth is rooted in the location for the longer term,” said Oxley.
This is in comparison to a trade sale where there are no guarantees that the business will be able to keep its culture, ethos, location and employees.
“It gives founders a way of exiting the business while sustaining the culture, ethos and values of the business while rewarding those who have supported the business in becoming a success and allowing it to continue its part in supply chains and serving the communities in which the business is based,” she added.
Shareholders get a full Capital Gains Tax exemption
If you own a trading company, you can now sell some – or all – of your shares to an employee ownership trust for full market value without any CGT liability.
Corporation tax deduction for companies providing share incentives
There’s corporation tax relief on payments to an EOT.
Quicker and smoother sales
Some shareholders want to sell to employee ownership trusts rather than doing trade sales. These sales are quicker and smoother than a sale through a third-party purchaser. This is down to fewer negotiations.
Cons of employee ownership trusts
As expected, there are also downsides to EOTs. Oxley said that ‘It still takes hard work and commitment and will not protect you from market pressures.’
Let’s take a look at some of them below.
Ownership is indirect, so the company doesn’t have full control. A trustee’s role is not to manage the company, but to make sure that the company is being led competently and in a way that ensures employee commitment and engagement.
A management structure will be agreed upon setting up the EOT. They need to have a say in the way the business is run so they’ll need to be considered – this could be in the form of an employees’ council, having employee directors on the board and having a company constitution to define values in relation to employees.
You need to trust the trustees will behave with good conduct
Going into an EOT relies on your trustees to follow the rule of equality.
Shareholders won’t receive the money for the sale immediately, so they take on more risk
Money from an EOT is paid to shareholders over time rather than straight away as it would in a market sale.
The profits in the business may not be enough to pay off all of the sale price in a reasonable timeframe, which could be a deterrent for shareholders. Bear in mind that the value received by the shareholders may be less than if the business was sold on the open market.
It’s not always easy to determine the value of the business
There can be a difficulty in agreeing the value of the business and the funds the shareholders receive from the EOT. Don’t fall into the trap of overvaluing the company though – you exacerbate risk by raising the price.
> See also: How to value your business
Complex and potentially expensive
EOTs operate on complex rules which can be difficult to grasp. Dips in company performance could also affect funding and prolong the process for selling shareholders. Sales are done on a gradual basis, often for several years.
The price can be variable too. “As with any transaction that needs legal and financial support, it depends on the cost of those services from the company (or companies) which you use. Generally, a transition to employee ownership does not cost more or less than a trade sale,” said Oxley.
Is an employee ownership trust right for my business?
Employment ownership trusts have their benefits but they’re not right for every business.
They could work for you if you’re retiring or interested in another succession plan. Alternatively, you might not feel a trade sale or management buy-out is suitable or you could be a start-up with a very strong team who have a shared purpose.
It could be a better shout if you’re a medium-sized business. EOTs have had particular success in companies with between 50 and 250 employees, even though general EOT numbers are still low.
Whatever you decide to do next, take a look at your other options before you decide on an EOT. For more advice, speak to a legal professional or head over to the Employment Ownership Association website.
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