Ownership for All: Navigating the Establishment of an Employee Ownership Trust

By Tim Sadka & Elizabeth Howlett

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Generating approximately £23.1bn of combined sales amongst the UK’s top fifty largest Employee Ownership Trusts (EOT) in 2023 (according to a survey carried out by the Employee Ownership Association (EOA)), EOTs have gained traction since the Finance Act 2014 thanks to UK Government tax incentives, which permit an exit without incurring capital gains tax liability for owners of trading companies selling shares to an EOT, providing they meet the qualifying criteria. The growth in popularity of EOTs can be largely attributed to the government tax incentives acting as a catalyst, as according to the EOA ‘90% of businesses that are currently employee owned became EOTs in the years following the EOT being enshrined in legislation in 2014’.

Almost any type of business can be part of an EOT structure in the UK; notable EOTs include the iconic UK household brand, John Lewis Partnership PLC, as well as A.T. Kearney Holdings Limited (2006), Adventure Forest Group Limited known as Go Ape! (2021), and Bennett Oakley (2022), in and amongst hundreds of companies both nationally and internationally.

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Qualifying criteria for beneficial UK tax treatment

• Are you a trading company or the principal company of a trading group? This is essential to consider, as the company whose shares are being transferred must identify as one or the other.
• Trustees who can apply restrictions on how settled property (shares) benefits all eligible employees on equal terms.
• Trustees must retain an overall controlling interest in the company (at least 51%) in order to qualify for its beneficial tax status.
• Continuing shareholders (and any other 5% participators) who are directors and employees (and also those connected to such employees and/or directors) must not exceed 40% of the total number of employees of the company or group.
• The benefit of trust property (e.g. the shares in the company) must be applied on the same terms for all eligible employees, however, the caveat to that is that trustees are able to exercise their right to distinguish employees on a basis that is linked to remuneration, length of service and hours worked.

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Advantages of EOT transactions v. a more traditional business sale

• If you are looking for a friendlier, potentially swifter and easier transaction which subsequently could result in lower professional fees than might be incurred from a sale involving a third-party not connected to the target business, an EOT may be a viable option.
• If you are a founder shareholder director relinquishing control strictly on shareholding terms, under an EOT you are permitted to remain as a director post-disposal and continue receiving market competitive remuneration packages including salary, pension, healthcare, car, etc.
• Funding needn’t be raised by employees personally as this is facilitated through the EOT, in order to indirectly buy the company from its shareholders.
• Subject to an independent valuation, shareholders are able to realise market value.
• The transaction is not contingent on ALL shareholders selling their shares to the EOT providing that 51% passes into EOT control.
• Capital gains, income and inheritance tax liabilities should not arise on an EOT sale providing that there is a properly implemented disposal of a 51% controlling interest, therefore making it a far more tax efficient transaction.

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Advantages once an EOT has been established

Subject to National Insurance contributions (for both the employer and employee), cash bonuses of up to £3,600 can be issued per annum in a single lump sum, tax free. Such a financial incentive in addition to share participation in the EOT helps to drive competitive advantage for the business.  This is because these bonuses:

• encourage employee commitment
• increase employee motivation and engagement
• reduce absenteeism
• create a more positive workforce
• decrease staff turnover
• increase profitability of the company

The robustness of EOTs has not gone unnoticed; an independent Nuttall Review of Employee Ownership in 2012 reiterated what some may have known for a long time. EOTs were found to be a ‘a powerful way of aligning the interests of employees with that of the business’, according to Norman Lamb, Minister of Employment Relations, Consumer and Postal Affairs (2012).

The opportunity for entrepreneurs and founder shareholders to successfully pass on ownership to an EOT is often not driven solely by the lure of a capital gains tax free transaction or the general advantages which can arise for the company and its employees under an EOT, but instead a more personal driver, for example:

• the ability to pass on a legacy;
• being in greater control of the sale price (of course, albeit in accordance with a formal valuation which is required to allow the trustees on an EOT to proceed with the transaction);
• a reduction in warranty and indemnity exposure (a common and expected occurrence in a third-party transaction); and
• the ability to retain a high degree of management influence whilst the price remains outstanding and in some cases, this may potentially be extended post-payment providing that the sellers maintain a shareholding as outlined previously.

In order for an EOT to effectively operate, there are several points to consider prior to pursuing this route, these include:

• Arrangements for management succession must be in place or be in a position to be implemented fairly swiftly.
• The financing aspect, as funding for an EOT may not be easily sourced. Potential solutions can include loan notes (secured or unsecured) or the financing of the valuation by the selling shareholders.

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For those who would like to know more, and for those already considering an EOT, please do not hesitate to get in touch. Tim Sadka has more than two decades’ experience both as a corporate lawyer and in business leadership and management roles, with a wealth of experience leading project teams in order to deliver their objectives in a transaction which is as seamless as possible. It is worthy to note that EOTs are an evolving concept, requiring expert collaboration; the Healys corporate team has a strong and proven track record handling corporate restructures and would be happy to assist.

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