15 March 2022
Acquisitions and Disposals
When the time comes to exit your business, you have a few important choices to make when it comes to the objectives behind your exit strategy. Do you want to make a clean break and end all ties with the company? Do you want to sell your shares but remain on the board? Or do you want to hand over your business legacy in a form that will continue to evolve and grow, with a trusted and competent executive team at the helm?
Thomas Dalby explains what an Employee Ownership Trust (EOT) is and the underlying tax benefits of selling your business through an EOT.
Why should you consider an EOT as part of your exit strategy?
In essence, an EOT is an indirect form of employee ownership where a trust holds a controlling stake in a company on behalf of all its employees.
EOTs also provide an incentive for owners to sell a controlling stake (>50%) in their business, by removing the requirement to pay CGT on any gains made when selling their shares in the business.
EOTs can also provide employees with tax benefits as well – bonuses of up to £3,600 can be paid out without paying any income tax, although these bonuses are still liable for NICs.
There are various reasons why the EOT route may appeal to an owner:
You may be retiring but your current management team is not in a position to consider a management buyout. Instead of going through the usual sale process, you may look at an EOT as a way to sell the business to your management team.
It may be that you don't want to give personal guarantees to finance the business and want to step back and exit. For many small businesses, there isn't a lot of separation between the shareholders and the directors that run the business, so moving to a partnership model might help to refocus things on the needs of the business.
You may feel that no-one else is ready to lead the business at this point. If you sell the business into the EOT, you needn’t give up your executive role – only your personal ownership of the controlling stake in the business. This gives you time to get the next generation up to speed and ready for a full management buyout at a later date.
Whatever your circumstances, having the option of using an EOT helps to broaden your choices as an owner. But how do you go about financing an EOT if this is your chosen route to exit?
What are the best ways to finance an Employee Ownership Trust?
EOTs will generally be set up through your third-party advisers. As the owner, you have to finance the process of setting up the EOT, but you don’t have to go through the lengthy negotiating process with a buyer that would usually be needed to get to your transaction.
There will usually be three sources of funding when it comes to sorting out the finance:
The company – the company itself may have cash reserves that can be given to the EOT to buy out the shares. You can’t drain the company of working capital entirely, so it’s unlikely that you’ll have all the cash to hand immediately. Where cash reserves don’t provide the required capital, additional sources of funding will be needed to cover the share buyout.
The shareholders – asking for funding from the shareholders themselves is another option. This is usually done by giving the shareholders loan notes. These loan notes can provide the required funding and can be paid off over time as you generate profits and cash. In this scenario, it would be reasonable for the shareholder to have some oversight, so you don’t run the business into the ground and they see a decent return on their investment.
The bank – asking your bank or other business lenders for a loan is an option to consider, but it’s not without its drawbacks. Getting a loan could be difficult, as any lenders will want to carry out due diligence on the business, in exactly the same way that a private investor would. This process can be a bit more robust and but can take away one of the key benefits of an EOT – namely, that the EOT route doesn’t require the lengthy due diligence process that an open-market sale would entail.
What’s the next step when forming the trust?
Once you have the finance in place to complete the share buyout, the next step is quite straightforward – you form the trust and move the indirect controlling ownership over to the trust, the trustees and the company’s employees.
There are two key elements to the trust: 1) the trustees and 2) the rules of the trust. The guidance doesn’t say who can be a trustee, so that’s up to you. Deciding who will act as the trustee is you next decision and there are generally three main options:
Set up a subsidiary company to act as a trustee – this means you’re not reliant on a third party for the administration. This can also reduce the costs of running the trust.
Have individuals acting as trustees - but there are a lot of risks involved in being a trustee as an individual. It’s an option, but not generally an advisable one.
Engage a third-party professional trustee - there are a lot of professional organisations that are now comfortable with EOTs and will happily take on the trustee role for a fee.
EOTs are now an established option in the market, because of the significant CGT benefits. As an owner who’s looking to sell up, opting for the EOT route offers some interesting choices and helps you deliver a healthy return on your investment in the business.
Helping you get the best from an EOT structure
If you’re thinking about your exit strategy, it makes sense to talk to an adviser and to get the best possible understanding of your EOT options.
To summarise the key benefits:
EOTs provide a good exit strategy for a business owner who doesn’t want to get private equity involved and doesn’t want the hassle of going out into the market. You can hand over your legacy to a good executive team and still retain some involvement and interest in the business.
An EOT helps your business to live on and retains your reputation and name in the market. No employee has a defined stake in the business, so the guys on the shopfloor won’t dictate everything and the management team can carry on with the best interests of the business at heart.
Being able to sell off your shares without paying any CGT on this gain is obviously extremely inviting to any owner. This tax relief has been a key driver in making EOTs popular and continues to be a benefit for owners that understand the underlying benefits of using a trust structure.
Instead of sitting through hours of meetings with private equity houses going through the books, you can quickly get a trust set up, finance the deal and get the whole process completed in a matter of weeks.
At Haines Watts London, we help owners make the most of the EOT route and can provide you with the end-to-end advice needed to complete the whole sale process. As advisers, we’re here to help you understand what you need from a sale, where your priorities lie and then help you facilitate the whole process of switching to an EOT structure.
Find out more about how an employee share scheme can support your exit planning.