Employee ownership trusts: a quick guide for your business

Our quick guide is designed to help you understand what an employee ownership trust (EOT) is, the legal aspects, and how it can potentially benefit your business.

What is an employee ownership trust (EOT)

An employee ownership trust (EOT) is a unique and increasingly popular business structure. It enables business owners to gradually transfer company ownership to their employees, who become beneficial business owners through the trust.

Key aspects at a glance:

• Legislation: The UK government introduced specific legislation to support EOTs, including the Finance Act 2014 and subsequent updates, which provide clarity and guidance on the tax benefits and requirements associated with EOTs.
   
• Ownership transfer: Business owners sell a significant portion or all of the company's shares to an EOT. The owner can retain some involvement (up to 49% of company shares)
   
• Trust structure: The EOT is established as a trust fund, with trustees responsible for managing the shares on behalf of the employees (at least 51% of company shares).
   
• Employee benefit: Through the EOT, employees remain employees, but become indirect company owners. As trust beneficiaries, they may receive financial benefits, such as bonuses or profit-sharing.
   
• Governance: Depending on the setup, employees may have a voice in the company's decision-making processes, potentially through representation on the board of trustees or other mechanisms.
   
• Tax advantages: The UK government provides tax incentives to encourage the adoption of EOTs. For instance, there may be capital gains tax relief for selling owners and income tax benefits for employees who receive bonuses or dividends from the EOT-owned company.
   
• Succession planning: EOTs offer a succession or exit strategy for business owners looking to sell their company while preserving its culture and legacy. This option is attractive for owners who want to ensure the continuity and success of their business in the long term.

Overall, EOTs serve as a mechanism to foster employee engagement, improve company performance, and facilitate smooth ownership transitions while enjoying favourable tax treatment from the government.

What are the key advantages of employee ownership trusts?

Employee ownership trusts offer many advantages for businesses and their employees.

• Enhanced employee engagement: Establishing an EOT can foster employee engagement by instilling a sense of ownership and accountability among staff members. EOTs promote a culture of transparency, collaboration, and accountability by allowing employees to participate in the company's decision-making processes.
   
• Improved company performance: Heightened engagement often translates into enhanced company performance, with employee-owned firms frequently outperforming their counterparts regarding productivity, innovation, and profitability.
   
• Recruitment and retention: Moreover, EOTs are powerful retention and recruitment tools. They provide employees with a tangible stake in the company's success, attracting top talent and incentivising long-term commitment.
   
• Tax benefits: From a financial perspective, EOTs offer tax benefits for selling owners, including capital gains tax relief, making them an attractive exit strategy. Simultaneously, employees may enjoy tax advantages, such as tax-efficient bonuses and profit-sharing distributions through the trust.
   
• Succession planning: Beyond financial considerations, EOTs also facilitate effective succession planning by providing business owners with a means to transition out of the business while preserving its legacy and culture. 

In short, by aligning the interests of owners and employees, EOTs contribute to the long-term sustainability and success of businesses while fostering an equitable wealth distribution, providing the selling owner with an attractive exit strategy.

What are the potential disadvantages of employee ownership trusts?

While employee ownership trusts (EOTs) offer numerous benefits, there are also potential drawbacks to consider.

• Limited liquidity for owners: Transferring ownership to an EOT may result in reduced liquidity for selling owners, as they may not receive the total value of their shares upfront. This lack of immediate cash flow could pose challenges for owners seeking to diversify their investments or address personal financial needs.
   
• Complexity and governance issues: Establishing and managing an EOT can be complex and requires careful consideration of legal and governance structures. Ensuring effective decision-making processes and resolving potential conflicts between trustees and beneficiaries may require significant time and resources.
   
• Risk of dividend dependency: Employees may become overly reliant on dividends or profit-sharing distributions from the EOT, which could lead to financial instability if the company experiences fluctuations in profitability. This dependency may discourage employees from advocating for long-term investments or reinvestment in the business.
   
• Potential tax implications: While EOTs offer tax benefits for both selling owners and employees, complexities and regulatory changes may affect the tax treatment of EOT transactions. Staying compliant with tax regulations and navigating potential changes in tax laws could pose challenges for companies operating under an EOT structure.
   
• Limited control for employees: Employees' status remains unchanged - they will still be employees. While they benefit from indirect ownership through the EOT, they may have limited control over critical strategic decisions or the company's day-to-day operations. This lack of control could lead to disenfranchisement among employees who desire greater influence in shaping the company's direction.
   
• Potential impact on company culture: Introducing an EOT may disrupt the existing company culture or dynamics, particularly if employees perceive changes in management or decision-making processes due to the trust structure. Maintaining a cohesive and inclusive culture while transitioning to employee ownership requires careful communication and alignment of values.

While these potential disadvantages should be carefully considered, they can often be mitigated through thoughtful planning, clear communication, and effective governance structures.

What types of businesses benefit from employee ownership trusts?

Employee ownership trusts are flexible structures that can be established by a wide range of businesses, including small and medium-sized enterprises (SMEs) and larger corporations. 

• Small and medium-sized enterprises: SMEs often face unique challenges regarding succession planning and business continuity. EOTs offer a viable solution for SME owners seeking to exit their businesses while preserving jobs and maintaining the company's independence.
   
• Family-owned businesses: Family-owned businesses looking to transition ownership to the next generation or non-family members may find EOTs particularly appealing. By selling shares to an EOT, family business owners can ensure a smooth succession process while retaining the company's heritage and values.
   
• Businesses seeking to preserve independence: Companies that value their independence and wish to avoid acquisition or takeover by larger competitors may find EOTs advantageous. By transferring ownership to employees, these businesses can maintain their autonomy and continue operating according to their values and principles.
   
• Businesses with a strong company culture: Businesses with a strong company culture and a history of employee engagement may benefit significantly from an EOT. By formalising employee ownership, these companies can further strengthen their culture of collaboration, innovation, and shared responsibility.

In summary, EOTs suit many businesses, including SMEs, family-owned businesses, and companies seeking to preserve their independence and company culture. 

What are the key steps to follow when considering an employee ownership trust?

Establishing an employee ownership trust involves careful consideration of the legal aspects. Engaging an experienced solicitor is crucial to ensure compliance and mitigate risks.

Stage 1: Preparing for sale

Begin by consulting with legal experts specialising in corporate law. A law firm with experience establishing EOTs can provide valuable guidance and advice tailored to your business's specific needs and circumstances.

Your solicitor will conduct an initial assessment to determine the feasibility and suitability of setting up an EOT for the business. This may involve evaluating the company's corporate structure, financial health, ownership dynamics, and employee situation.

Careful consideration must be given to the company structure, including the impact of retained and minority shareholdings, senior management share options, and the terms of the deferred payment.

Based on the assessment, your solicitor will work with the business owner to structure the EOT to align with the company's objectives and comply with legal requirements. Before setting up an EOT, you must also obtain clearance from HMRC, which usually takes one to six weeks.

You will need to engage independent valuation experts to assess the value of the company's shares and determine the terms of the share transfer to the EOT. This process ensures that the transfer is fair and transparent, benefiting both the selling owner and the employees.

Throughout the process, it's essential to communicate effectively with employees and engage them in the transition to employee ownership. This includes explaining the benefits of the EOT, addressing any concerns or questions, and fostering a sense of ownership and commitment among the workforce.

Stage 2: The sale

This is the stage where the business's purchase takes place. Your legal experts will prepare the necessary legal documentation, including the detailed trust deed, share purchase agreement, and any other relevant contracts or agreements. They will also ensure compliance with regulatory requirements and tax implications for establishing the EOT.

In this process, the employee ownership trust will acquire a controlling stake in the company by buying out the existing or exiting shareholder. For the acquisition to be successful, the EOT must obtain at least 51% of the shares. 

Additionally, any excess funds available in the trading company's balance sheet can be contributed as a gift to the EOT during the transaction's completion. These funds can be utilised to finance a portion of the purchase price.

Stage 3: Implementation and ongoing legal support

Once the EOT is established, the existing shareholders will usually receive deferred payments for the purchase balance, which the trading company's ongoing profits will fund.

Your solicitor can provide ongoing support to ensure its effective operation. This may involve advising trustees, updating documentation as needed, and addressing any legal or regulatory changes that arise.

Finally, regularly monitoring and reviewing the EOT's performance is important to ensure it continues aligning with the company's goals and objectives. This may involve periodic assessments, reviewing governance practices, and making necessary adjustments to optimise employee ownership benefits.

Contact our corporate solicitors

Employee ownership trusts can provide businesses with a pathway to empower employees, ensure seamless ownership transitions, and access tax advantages. While offering benefits like enhanced engagement and improved performance, careful planning is necessary to address potential drawbacks. 

If you're a business owner looking for guidance on how to use EOTs to achieve long-term success, our solicitors can help. We can also assist you in determining whether an EOT is a better option compared to a management buy-out or a trade sale.

We have solicitors in London, Brighton, Eastbourne, Hastings, Uckfield and Ulverston, and we work with business owners nationwide.