In the middle of a somewhat momentous budget yesterday, an announcement was made which will have a significant impact on many owners who are considering selling their business at some point over the next five years.
The change to entrepreneur’s relief may tempt some to sell to the Employee Ownership Trust (EOT) in order to save tax. I’d like to explain this change and provide a note of caution.
What Is Entrepreneurs Relief?
When a business is sold, capital gains tax is payable on the difference between the purchase price and the sale price. For a founder, this is likely to be virtually the whole value.
The rate of capital gains tax payable on the sale of shares is up to 20%. For a sale of £2m, therefore, £400k of tax would be due.
If certain criteria are met (for example, the owner of the shares must have been an officer or employee for at least two years prior to the sale), then entrepreneurs relief is available. Pre-budget, this reduced the rate paid on the first £10m to 10%. For our owner selling for £2m, therefore, £200k of tax is due, a saving of £200k.
The change in the budget means that the amount of gain that will apply to this reduced rate reduces from £10,000,000 to £1,000,000.
For our sale of £2m, therefore, the tax to be paid will now be £300k, an increase of £100k in tax.
The Employee Ownership Trust Tax Advantage
The tax position for the sale to apply ownership trust is that 100% of the proceeds are free from capital gains tax, with no limit (again, assuming a number of conditions have been met – get in touch for details).
For our friend selling for £2m, therefore, this is a £400k saving.
This in itself would seem to be a pretty compelling argument sell to EOT. But…
The Tax Tail
As any good accountant will tell you, you should never allow the tax tail to wag the dog. Do not do anything purely to save tax, it must be the right thing to do in the first place.
An EOT owned business does not look and act like a privately owned business. The cultural changes required as a result of the employees being in control (via the trust) are significant and take time to prepare for.
The Earn Out
Like most types of sales of small businesses, the sale of shares to an EOT are typically funded by cash held within the company, and then from future profit.
This means the owner is paid from future profit of a company that they no longer control.
This is a compelling enough reason why time should be taken to prepare the business for the sale to an EOT. Our advice is that such preparation should not take less than 12 months, preferably at least two years.
Issues that need to be covered include: giving the employees a voice; employees acting like business owners; new types of leadership; the role of the founder; and many, many more (our online programme has some 200 individual lessons).
My Business Is Different
Many (most?) owners tell me that their business is already in good shape for employee ownership, that their employees are already engaged.
This will not be the case. Things change when the business becomes employee owned, and in ways that are impossible to foresee.
The Importance Of The Right Preparation
Take the time to prepare, and the EOT is a fabulous route for succession. Indeed, it is arguably the only one which offers the chance to receive full value (yes, and tax-free) and allow the owner to see the business continue as their legacy.
It does, however, take preparation.
If this change to entrepreneurs relief has led you to think or rethink the possibility of selling to an EOT, please get in touch so we can discuss how you can best prepare your business for this change.
