EOTs were introduced by the Government in September 2014 as a way of encouraging employee ownership of companies. It is becoming an increasingly popular way of structuring exits for business owners and has a number of advantages for both the seller and employees.
How it works:
- The EOT is set up with a corporate trustee to manage the EOT and make decisions on behalf of the shareholders.
- The shareholders sell at least their controlling interest to the EOT. Whilst this might include an initial cash payment, part of the purchase is likely to be funded by loan notes.
- The company continues to trade, generating profits. These profits are paid to the EOT, which are then used to repay the outstanding debt to shareholders.
Advantages for Sellers:
The sale of the shares should be free of capital gains, inheritance and income taxes. For those impacted by the recent changes to Business Asset Disposal Relief (previously Entrepreneurs Relief) this will no doubt be very attractive.
Given the tax advantages, and the relative ease of the exit, some may be wary of entering into an arrangement which seems too good to be true. However, the shares cannot be purchased for less than the full market value, and the terms of sale are unlikely to include target related earn-outs as would be common in other types of transaction. All too often these earn-outs are never paid in full.
Whilst the EOT must purchase and retain at least a 51% controlling interest in the company, the shareholders can still play an active role in the management of the company. In addition, not all shareholders are required to sell their shares to the EOT. That said, the number of continuing shareholders, and persons connected to them, must not exceed 40% of the total number of employees of the firm.
Advantages for Employees:
An EOT allows employees to indirectly buy the company from its shareholders without them having to use their own funds, one of the main stumbling blocks for more traditional MBOs.
Studies show employee ownership creates a greater sense of engagement, commitment and improved business performance. For example, for many years the quality, loyalty and longevity of John Lewis staff was admired throughout the retail sector.
Employees can receive an annual tax-free bonus of up to £3,600. This could result in tax savings for employees of between £720 and £1,620 each year.
For business owners considering an EOT as a part of their potential exit plan, it is vital you take advice from experienced corporate tax and legal advisers. At Integrity365, we can recommend specialists in this field and will be delighted to introduce you if required. Get in touch today on 0117 450 1300.