Everything you need to know about moving to an EOT structure

27 February 2024

Everything you need to know about moving to an EOT structure

Employee Ownership Trusts (EOTs) are an increasingly attractive way for founders to pass on their businesses. In addition to compelling tax advantages, practical considerations and fee structures, there is also an appealingly personal draw to transferring the ownership of a company to its employees, rather than an anonymous third-party.

Haines Watts Chester Associate Director Matt Davenport has worked with hundreds of businesses to manage a successful exit strategy and create effective succession plans. Here he explains the key aspects of EOTs and how to work out if  it could be right for your business.


What is an Employee Ownership Trust?

An Employee Ownership Trust (EOT) is a specific type of employee benefit trust that facilitates wider employee-ownership, via an indirect holding. In an EOT, controlling shares in the business are held by a trust company that sits above the organisation. However, unlike a standard share structure where dividends are distributed to individual shareholders, an EOT sees profits distributed to employees directly, via a tax free bonus.

These schemes have grown in popularity, with the Government offering preferential tax breaks to encourage shareholders to move to an employee-ownership model, however this requires conforming to a particular structure.


How do I know if an EOT is right for me?

EOTs provide a compelling exit strategy for business owners looking to retire or move on without selling to a third party, thus preserving the company's culture and operational continuity. To qualify, it must meet five basic conditions:

  1. The company must be a trading company or the principal company of a trading group
  2. Trustees of the EOT must restrict the application of any settled property (the shares) for the benefit of all eligible employees on the “same terms”
  3. The trustees must retain a majority share – at least a 51% – controlling interest in the business
  4. Continuing shareholders who are directors or employees must not exceed 40% of total employee numbers
  5. Trust property must generally be applied for the benefit of all eligible employees on the same terms.


What are the benefits of an EOT?

This structure is particularly appealing for those wishing to secure a legacy, ensuring the business remains in trusted hands while also extracting capital value. Practical benefits include:

  • A quicker and easier transition of the company to the employees, via an employee ownership trust, rather than an expensive, drawn out sales negotiation with an external buyer.
  • Simplifying the management buy-out process by deferring payments in line with the earnings of the business
  • Using employee-ownership to retain key contributors within the business
  • Allowing shareholders to claim a full UK capital gains tax exemption on the disposal.


What are the Tax Benefits of an EOT?

The tax incentives associated with EOTs are substantial, encouraging more businesses to consider this route:

  • Capital Gains Tax (CGT) Relief: Sellers to an EOT are eligible for 100% relief from CGT.
  • Income Tax-Free Bonuses: Employees of EOT-owned companies can receive bonuses up to £3,600 annually without any income tax, directly benefiting from the company's success​​.
  • Inheritance Tax (IHT) Exemption: Transfers of shares to an EOT are exempt from IHT, and the EOT itself is not subject to the IHT relevant property regime​​.

The growth in the business's value benefits the EOT, and indirectly, the employees, without the complexities associated with direct share ownership and dividends.


How Do You Set Up an EOT?

Setting up an EOT often involves a deferred buyout strategy, where the sale price is paid over time from the company's future profits. This approach does not require external funding and aligns the interests of the employees with the company's long-term success.

An initial payout may be made at the point of transition, with future payouts structured over a defined period, incentivising the team to drive value growth.


What are the challenges of setting up an EOT?

The goal of an EOT is to incentivise employee engagement within the business by giving them a concrete stake in its success.. That means that the transition to an EOT requires the business owner to tangibly relinquish control, a significant shift that necessitates a careful selection of trustees.

This board should include a mix of current employees, external advisors, and possibly a departing shareholder, ensuring a balanced governance structure that represents a wide range of perspectives.

  • The government has proposed that more than half of the EOT trustees should be individuals not connected to the former owners, to ensure that the EOT delivers meaningful change for employees. This goal here is to prevent former owners from retaining control through the EOT trustee board​​.
  • To prevent tax avoidance, EOT trustees should all be UK residents, or if there is a mixture of resident and non-resident trustees, the former owner should be UK resident or domiciled at the date the shares were disposed of to the EOT​​.
  • Since EOTs might not have their own funds initially, the consideration for the shares is often paid over time, funded through profits. This aspect requires careful planning to ensure the sustainability of both the EOT and the ongoing business operations​​.

While employees must be eligible for bonuses, it is possible to attach conditions to their payouts, such as minimum terms spent in the business.


Setting Up for Success with Haines Watts

For businesses considering the transition to an EOT, Haines Watts can help guide you through the process, from structuring the board of trustees to ensuring tax compliance. We can also connect you with our wide network of experienced legal advisors to support you in making the right decisions for your company, your family and your employees.


To find out more about moving to an EOT structure, why not get in touch with our team?