The Employee Ownership Trust (EOT) made the front page of the Sunday Times this weekend.
I’d like to explain why not all publicity is necessarily good publicity.
Apparently, according to the Sunday Times Business & Money section, the government is planning to reduce the scope of Entrepreneurs’ Relief.
To remind you, the current rules are that, if certain conditions are met, then up to £10 million proceeds from the sale of a business are subject to a reduced Capital Gains Tax rate of 10%.
The suggestion is to reduce this threshold to £1 million, from the forthcoming budget on 11th March 2020.
The article, therefore, suggested that the tax-free schemes, such as the EOT, will become increasingly attractive if entrepreneurs’ relief is cut back.
The tax rules for the EOT are very simple. Proceeds of the sale to the owner are free of Capital Gains Tax. Additionally, profit distribution to the employees is free from Income Tax up to £3,600.
There are several reasons why the comment from the Sunday Times article could be harmful. Indeed, this highlights the mindset that is so key in ensuring a successful transition to the EOT.
The basic reason is that the EOT is not simply a ‘tax-free scheme’.
Building A Business To Last
By placing control of the business in the hands of the employees (indirectly via the trust), the EOT shares both profit and influence among the people who work in the business. They are not there for a short-term interest share price; they are there to build a business for the long term.
This can be very different from the traditional privately owned business and takes time to build. This is especially true of a business which is heavily influenced by the founder or owner.
Issues that need to be covered include: giving the employees a voice; new styles of leadership; employees becoming trustees, responsibility for holding the board to account; employees thinking like business owners; and many other fascinating aspects of an EOT owned company.
A company that has sold to an EOT without any notice to the employees, simply so that the owner can save some tax, is not going to be ready.
The Earnout Issue
Occasionally, the majority of the payment for a sale can come from cash held within the business. Usually, however, at least some and often all the payment comes from the future profit of the business.
This means the owner sets up the EOT, relinquishing control, and then gets paid from the business that they no longer control.
This is not something that most owners would want to do until they are certain that the business will thrive without them.
An owner that is focused on saving tax, and does not prepare their business, may well find that the business they leave behind is not best placed to pay them.
A Fabulous Exit
For many business owners, the EOT offers the only exit which will give them a fair value for their business, plus seeing the business continue, and leaving a legacy.
There is no getting away from the fact, however, that it does take time to prepare the business. Of course, this is no different from any other exit – the value of the business will always be maximised if time is spent preparing the business for the sale.
The EOT is, therefore, best seen as an ideal exit, with the tax savings being a bonus. Things that are done simply to save tax have a habit of going wrong, and selling a business to an EOT before it has been prepared has the hallmarks of being one of them