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Employee Ownership Trusts: an alternative to a company exit
- AuthorRichard Pull
There is growing interest among company owners in considering a sale to an employee ownership trust (EOT) in order to realise value locked up in the business, whilst retaining overall ownership in a trust on behalf of all employees.
In order to encourage employee ownership, it has been possible since 2014 for business owners to sell a majority stake in a company to an EOT and incur no tax on the sale. The sale price is determined by an independent valuation expert, and to the extent that the EOT does not borrow to pay the whole price immediately, any deferred portion of the purchase price is effectively paid to the selling founders out of the profits of the business in future years. In addition to the capital gains tax exemption, the company is subsequently able to pay tax-free cash bonuses of up to £3,600 a year per employee.
This package of tax measures is designed to encourage business owners to establish employee-owned businesses which can uphold and develop the culture and energy which was critical to the business’s success. A feature of the model is that founders may continue to be involved in the business following disposal, for as long and in such capacity as is agreed, and can continue to receive remuneration at market rates.
Although interest in a sale to an EOT might be triggered by available tax reliefs, business owners should genuinely wish to facilitate ownership of the business by employees. Since it is likely that the selling owners will be paid out over a period of years from the ongoing profits, unless they have a real interest in seeing the business flourish over future years, they might find the clean break of a trade sale a preferable exit opportunity.
According to the Employee Ownership Association, there are 350 businesses in the UK which have adopted the employee-owned model. The biggest and best known of these is John Lewis, whose employees have been ‘Partners’ since 1929. The JL partnership constitution begins: “Because the Partnership is owned in trust for its members, they share the responsibilities of ownership as well as its rewards – profits, knowledge and power.” This attraction has proved critical for other businesses which have more recently embraced the employee ownership model. When Guy Singh-Watson transferred a 76% shareholding in online food company Riverford Organic Farmers in June 2018 to an EOT, he commented:
“To sell Riverford as a tradable chattel, whose purpose would be to maximise short term returns for external investors, feels to me a bit like selling one of my children into prostitution.”
And when Julian Richer sold 60% of Richer Sounds to an EOT in May 2019, he emphasised that the structure would avoid a third party investor “changing the strategy”, and commented :
“My hard working colleagues … should receive any benefit from running the business once my time is up. They know the business, and especially our rather unusual culture, extremely well and the business is therefore far more likely to flourish under their own steam because of this.”
Other companies that have also adopted the structure include Aardman Animations (the studio behind Wallace and Gromit) and Agilisys (a provide of managed cloud-based services).
Apart from the tax advantages introduced in 2014, why are businesses now starting to embrace employee ownership?
Deb Oxley, CEO of the Employee Ownership Association, states that employee-owned businesses have higher levels of employee engagement, and create more trusting environments which enable employees to work more effectively. Oxley comments:
“This culture differentiates these businesses as attractive employers for future staff, helps retain the best talent, and directly supports better wellbeing. This in turn unlocks the discretional effort from employees that leads to higher levels of productivity.”
Company founders may give little weight to these considerations if they wish to cash in and move on. But often founders have a profound connection with the business and will seek to ensure that it continues to flourish after they have ceased full-time roles. The tax advantages of the EOT model provide an attractive backdrop against which business owners will increasingly consider whether sale to an EOT, enhancing the employee engagement and enthusiasm which founders have nurtured, provides the best route for the future success of the business, and a lasting legacy for the founders.
This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 0207 404 0606 and ask to speak to your usual Goodman Derrick contact.