The employee owned sector is changing. Over the last few years, we have seen growth in employee ownership as a succession plan for many UK family businesses. This is largely because evidence shows us that by bestowing ownership on employees and giving them an opportunity to decide on the future of a business, there is a direct positive impact for all stakeholders.
There are not only benefits for individuals and their families, but also for the business, which can usually be seen through an increase in productivity, growth in profitability, greater resilience and more inclusive and effective employee engagement.
Employee ownership can come in many different guises, ranging from simple option arrangements, tax-advantaged share purchase arrangements, creating specific shares (often referred to as ‘flowering’ or ‘growth’ shares), or by a simple transfer of ordinary share capital. It is possible to combine many of these elements together to create bespoke incentivisation arrangements that work for you and your business.
However, if your plans are bigger than just incentivisation and you would like to realise some or all of the value you have created, you might consider your employees as the purchasers of your business.
Selling to your employees, if structured correctly, can qualify for a complete relief from capital gains tax. Tax should not be the sole reason for entering into transactions but if you think your employees are the best future owners for your business then you should consider this relief more closely.
To get the relief, the sale is made to an employee ownership trust (EOT) where the beneficiaries of that trust are the employees. The exiting shareholders and trustees agree a value for the company and the shareholders sell their shares to the trustees. The key conditions for the relief to apply is that the company is a trading company and the trustees must acquire at least 51% of the company shares.
The consideration for the sale is usually left outstanding on a loan account until the EOT has sufficient funds to make the payment – although sometimes third-party financing is obtained. The trading company can make gifts to the EOT when it has cash available. Such gifts should not be taxable in the hands of the EOT, although it’s strongly recommended you obtain HMRC clearance that this treatment will apply. These funds are then used by the EOT to make payment to the seller.
The clear tax benefit of using an EOT is that the exiting shareholders can sell their shareholding to the trust completely tax-free. Given the recent reduction of the entrepreneurs’ relief lifetime limit to £1 million, this tax exemption is now even more valuable. Moreover, there is no limit on the value of the company that can be sold to an EOT.
A company owned by an EOT can pay income tax-free bonuses of up to £3,600 to each employee each year.
EOT’s are particularly useful for family owned businesses where there may not be a family member in the next generation who wants, or is able, to take on the running of the business. They are also used in situations where the current business owners do not want to sell to a competitor. Employee ownership should not be a place of last resort for succession planning but a model for sustainable, scaleable, successful business where employees are the custodians, drivers and beneficiaries of a financially sound and strong business.
There are many benefits to an EOT, but there can be some downsides and it’s important to understand how this could affect you, your business and your planning. The trust must control the company, in other words it must have more than 50% of the votes and must have more than 50% economic entitlement over the company.
The price achieved on a sale to the trust may be slightly lower than the price you could achieve on a sale to a third party, although this may well be outweighed by the tax benefit, so your net proceeds may be similar.
The sales proceeds may not be received for a number of years and the seller has no security over the deferred consideration. It will depend on the cash available in the company to make the gifts to the trust, or the trustees being able to raise external finance, but this itself would probably also rely on the company results.
You cannot control the company – but you can have influence, especially if you have retained some shares. You would normally look to appoint professional trustees to help in this area.
The sale to an EOT is not the same as a sale to management. A sale to the management (usually referred to as a Management Buy Out) is generally a sale to a specific group of managers, backed by a funder who provides them with the means to buy your shares. An EOT must be for the benefit of all eligible employees rather than just a few, and all employees must be eligible to participate in the bonus scheme, although different bonus amounts can be paid to employees based on remuneration or length of service.
If any of the conditions cease to be met, there will be a disqualifying event. If this happens within a year of the end of tax year in which you sell, then your tax saving will be clawed back from you by HMRC. After that, it becomes a problem for the trustees who will be deemed to dispose of and reacquire the shares at their market value, probably resulting in a CGT liability.
EOTs present a viable option for many family businesses, as it provides a business model that can adapt to the changing needs and demands of running a business in the 21st century.