Succession planning and alternative exits: is an employee ownership trust the next step in your company’s growth journey?

Employee Ownership Trusts (EOTs) provide companies with an alternative exit strategy that does not include an external buyer. The structure enables greater employee engagement and a succession plan that can accelerate growth, create a platform for stronger communication and an inclusive culture. In addition, a sale of a company to an EOT can be entirely free of capital gains tax (CGT).

In March, we published an Insight article on how EOTs could help company owners hit by changes to entrepreneurs’ relief (now to be known as business asset disposal relief) in the latest Budget. It is likely that we will see more deals of this nature as owners seek to lock in both value and tax rates. With a reduction in trade sales, the succession planning route of employee ownership provides a straightforward exit that may be an attractive alternative.

What is an EOT?

In 2014, new tax reliefs were introduced to facilitate employee ownership. The Government introduced these reliefs because it considered that employee ownership would lead to greater employee engagement, higher productivity and lower staff turnover.

To sell to an EOT without any liability to CGT, shareholders must together dispose of a controlling interest of over 50% of the shares in a trading company or holding company of a trading group to a trust. The trust then holds the share capital of the company for the benefit of the company's employees.

The most common approach is for an EOT sale to be funded using future trading profits of the company. It is also possible, however, to use bank borrowing to finance part of the sale consideration.

Once the initial consideration is paid off, future profits of the business or gains realised on an exit will be realised for the benefit of all the employees.

It is not possible to transfer ownership of partnerships or LLPs to an EOT free of CGT as the reliefs only apply to sales of company shares. However, such businesses could first be transferred to a company before being sold on to an EOT. This can be done on a tax-neutral basis.

What are the key advantages?

Provided the qualifying conditions are met, no CGT will be payable on the disposal of shares to the EOT by UK resident taxpayers. This will be of particular benefit to any owner otherwise subject to CGT at full rates, currently 20%.

With the introduction of new tax legislation which has reduced the old entrepreneurs’ relief lifetime allowance from £10m to £1m, an EOT structure is particularly tax efficient. A shareholder disposing of their shares to an EOT will not be liable to CGT for the shareholder if the qualifying conditions are met.

A company that is majority-owned by an EOT can make annual bonus payments of up to £3,600 per employee income tax free.

Shareholders can sell their shares for market value (without an external third party purchaser. An independent valuation is required.

The day-to-day running of the business can continue, with the directors continuing to operate the business and receiving an arm’s length remuneration package.

The sale process should be more straightforward than a sale to a third party purchaser, such as a trade buyer or a private equity fund. It can also be quicker and less costly than alternative exit strategies with lower transaction costs and fewer due diligence requirements.

Reasons to consider an EOT

Employee-owned company structures can enable a smooth ownership transition process to the employees, minimising business disruption and protecting and enhancing the valuable culture and ethos of the business. There can be a seamless transition in ownership.

The structure can allow owners to reward long-term loyalty. It provides a platform for greater employee engagement and encourages higher employee retention for the business at a time of transition of ownership.

An EOT also enables employees to participate in the long-term growth of the business, as they will benefit from the future profits of the business. This often leads to higher productivity and accelerated growth for employee-owned businesses.

In contrast to a traditional sale process, a sale to an EOT avoids the need to disclose confidential and valuable details to competitors and to the outside world. The existing management team can continue to run the business; there is no need to hand control to external parties.

With employee ownership becoming increasingly popular, the Employee Ownership Association reports that an EOT can improve productivity, performance and engagement whilst creating an inclusive, transparent and effective method of governance.

How can Smith and Williamson help?

If you would like to learn more about EOTs, then please contact our team who can support you with:

• Structuring a sale to an EOT, including valuation advice;
• Cash flow modelling;
• Advice on the tax structuring and accounting treatment of the transaction;
• Personal tax planning and compliance work for selling shareholders; and
• Bonus planning and share schemes advice post-sale.

For advice please speak to:

Ref: NTAJ14062079

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.