Is an Employee Owned Trust right for your family business?

There has been a surge in interest in Employee Owned Trusts in late 2020 and early 2021. Some of this was driven by advisers, who were marketing the tax-free sale of shares to an EOT to pre-empt the proposed increase in Capital Gains (CGT) rates, but there was much more interest triggered by the pandemic prompting family business owners to seriously think about succession planning.

This may be because some family business owners felt that responsibilities were perhaps too focused and reliant on a small number of individuals, whilst some felt the effects of “Covid-19” fatigue with all the responsibility on their shoulders prompting them to consider if now is the right time to step away from the business.

Succession planning is a vital part of every family business strategy, but Employee Owned Trusts can offer an alternative route to succession. Trusts come in many different structures that can be incredibly flexible and tax-efficient and ultimately how and when they are used can be bespoke to your needs.

One of the original reasons for introducing the EOT regime was to reduce the complexity of employee ownership by offering a standard “approved” framework. This originated from the Nuttall Review which was published in 2012 when the UK economy was recovering from the Credit Crunch and attention was focused on the resilience of employee-owned businesses both in the UK and abroad. EOTs would therefore seem to have a natural place again as part of a post-covid-19 economic recovery plan.

An EOT is essentially a trust, set up to hold a controlling interest in a company’s shares for the benefit of employees. Beyond that, there is no obligatory structure for running the business so this can vary from the EOT trustees taking no active part in business management to, for example, the original owner together with selected employees being trustees and having responsibility for the strategic management of the business.

There can be more or less employee consultation depending on what suits the business. Some businesses have found that the dual structure of board of trustees and board of directors is an ideal way of bringing through senior managers who are first appointed to the board of trustees to get a feel for running the business in a safe environment.

EOTs and tax

Although there are a number of conditions to satisfy (primarily these are assurances that the business is properly held for the benefit of employees), EOTs have attracted attention because shares can be sold to an Employee Owned Trust free of Capital Gains Tax.

While some see this as their main selling point, our view is that the tax-free sale might best be regarded as “compensation” for converting to employee ownership. You can almost certainly achieve a higher selling price, an accelerated payment schedule and greater security of payment by selling to a trade buyer or institutional investor. The tax advantage of a CGT free sale for the business owner is really a peripheral issue.

The more fundamental question is why family businesses would choose to sell to an Employee Owned Trust when there is the potential to gain a better upfront selling price from a third party. The reasons for this are many, including:

preserving culture and values
maintaining manufacture or employment in a particular location
- provide a structure for the existing employees to take the business forward, ultimately becoming stewards
protecting the business from predation and asset stripping

Perhaps the overarching reason for family businesses considering an EOT would be to ensure their “legacy”.

Benefits of employee ownership

Not only do EOTs offer generous tax relief, they also potentially offer additional benefits.

Academic research has identified the following characteristic in employee-owned businesses:

stronger financial performance
higher productivity
improved ability to deal with crises
better employee retention
greater engagement and accountability

Looking forward, EOT owned businesses may have a strategic advantage in attracting talent. During the pandemic many businesses pushed through furlough and redundancy programmes with little or no consultation. Some highly leveraged businesses found that their finances were too precarious to withstand disruption and have also laid off staff. It is easy to see that many disengaged employees might opt to join an employee-owned business because of a poor experience through the pandemic.

Leaving aside the pandemic, many employees (and customers) put a value on a business’s ethical and environmental values and employee ownership chimes very well with the Fairtrade and climate change agenda.

Why choose an EOT

Although it can feel like there is a political dimension to siding with employee ownership, businesses which operated through professional partnerships or collective investment schemes have never been accused of choosing their business structure for political motives. For individuals considering EOTs and employee ownership, there may be a natural fit with business culture that makes the EOT framework attractive.

A major benefit is that the EOT tax reliefs do not require business owners to retire from the business. The owner of a family business can sell their shares and stay actively involved as trustees and/or directors.

For many owners, an EOT has been a way of phasing into retirement or just moving to a part-time role but with the ability to exercise oversight to help ensure that everything in the business is functioning effectively. A really attractive feature for some family business owners has been the opportunity to hand over their administrative and operational duties to other staff members or the next generation and get back to what they really enjoy doing, whether that is designing new products, meeting customers or just being the brand ambassador.

The EOT is just a framework, but the combination of generous tax reliefs and its flexibility means that it can suit a wide range of circumstances and personal preferences. It provides a framework resulting in little disruption, greater confidentiality, and more opportunities for the existing employees and family members to acquire ownership as well as positioning the family business for its next phase of growth.