The Employee Ownership Trust (EOT) was introduced by the UK Govt in 2014 to provide a new solution to succession planning. A company owned by an EOT allows employees to control and receive profit from a business without having to actually buy shares.
It is also allows the owner to sell their shares to the EOT for a fair market value and yet still see that business continue.
The EOT is an alternative to a management buyout which doesn’t require the management team to go into debt, nor does it create a ‘have and have not’ situation within a business.
The common expression for an EOT business is that they are ‘employee owned’. In fact, this is a little misleading. A better (but considerably less catchy) expression is ‘employee controlled and indirectly owned for the benefit of the employees’.
The first questions owners and advisers often ask tends to relate to the technical aspects. How does an EOT work? What is the tax position? How can I get tax and legal advice?
Before addressing these there is a crucial point. Although the EOT is an ownership structure, what we are really talking about here is making sustainable businesses. The word Eternal is used in the website, book and course for a good reason!
This is how it works. Rather than the company being owned by an individual, it is owned by a trust. The beneficiaries of the trust are the employees. The profit from the company is therefore distributed to the employees.
There is a tax benefit of an EOT. The employees can receive up to £3,600 income tax free (but not, currently, free from national insurance).
That’s it! John Lewis and Arup are two of the companies that have been owned this way for decades. The difference now is that the EOT, introduced in 2014 following the Nuttall review, is an off the shelf trust, making employee ownership accessible for all.
This is the process of moving a privately owned company into an EOT
- The company establishes the EOT.
- The company is independently valued.
- The owner(s) sells their shares to the EOT.
- The EOT pays for the shares from reserves and out of future profit.
Note that the payments are to the owner are free from capital gains tax.
Once the payments for the shares have been completed, the net profit is available for the employees. It is also possible that the payment structure allows for some profit above the repayments to go to the employees during the period of repayment.
The precise nature of the deal is up to the owner, but there are a few rules the trust must adhere to in order to qualify as an EOT:
- The shares can’t be sold for more than the valuation (although they can be sold for less);
- You don’t have to sell 100% of the business, for example the owner(s) may retain some shares for future income. The trust must, however, have control, so 51% shareholding at least;
- Reserves can be used for an initial payment;
- All future profit can be used for payments. Alternatively, payments might be fixed, with the rest being used for business purposes, or perhaps to make a distribution to the employees;
- There is a fair amount of flexibility. BUT the golden rule is this: if the deal is disadvantageous to the employees, they are unlikely to be inspired to keep the business profitable.
Equally as important is that the company is now owned by the trust, the beneficiaries of which are the employees. Employee-owned businesses therefore encourage, nay, need, employees to become involved in the decision making of the business.
The Eternal Business
Here is the key sentence for an owner looking to transition to an EOT:
The future payments to the owner are going to come from the profits of a business you no longer control.
This is, of course, no different from any other business sale. Rather than performing due diligence on the acquiring business, the owner has the chance to get their own business in shape before they sell.
Employee-owned businesses are not like privately owned businesses. There are four areas that make a successful employee-owned business, and the ownership structure is only one of them.
Each of these four areas need to be worked on together for the transition to be successful. There is much work to be done in making the business a ‘proper’ business (as opposed to a ‘personality’ business – one that is based around one or a few individuals).
These four areas form the Eternal Business model of transition to an EOT.