Succession Planning – A New Way: an Employee Ownership Trust (EOT)

For many business owners, the sale of their business is a process that they are dreading. What should be the pinnacle of a business owner’s career can instead be a highly stressful time.
It is for this reason that so many owners fail to prepare for the sale of their business. The irony is that by leaving it too late, owners massively reduce their options.
Since 2014, there has been a new option: the Employee Ownership Trust (EOT). Chris Budd of The Eternal Business Consultancy explains how it works.

The Ideal Exit

High on the list of requirements when exiting a business will be to receive a fair value for the business. For many owners, however, seeing the business continue is also important, looking after clients and continuing to do the thing they set out to do in the first place.

The ideal exit for an owner, therefore, is a fair value and leaving a legacy. Not a combination that is typically on offer.

For employees, clearly the continuation of the business and therefore their jobs will be high on the priority list. Fulfilment and purpose is a big factor in job satisfaction and remuneration – many employees will relish the opportunity of being able to get involved with the running and direction of the business.

Employees often also want ownership, although not all will want to actually own shares. As well as the responsibility that share ownership brings, many employees simply will not have access to the sort of money might be needed to buy out owner (or be willing to put their house on the line in order to borrow the money).

For employees, therefore, the ideal exit would be access to profit without the risk, having a voice in the business.

Both the owner and the employees can have what they want with the EOT – with the right preparation.

Exit EOT

The Employee Ownership Trust

A business is owned by its shareholders. The profit goes to the owners of the business, the shareholders.

In the case of the EOT, it is the trust which owns the shares (those familiar with the John Lewis Partnership is owned in this way). The beneficiaries of the EOT are the employees of the business. This means that the profit goes to the EOT, which then distributes the profit to the employees.

For a business owner, this provides an opportunity to exit the business and achieve all of the above criteria. This is how it works.

Step one: the company sets up its own EOT;

Step two: the owner sells their shares to the EOT;

Step three: the EOT receives the future profit of the business;

Step four: this future profit is then used to pay the owner for the shares;

Step five: each year, once the due payment the owner has been made, any profit over and above that amount is distributed to the employees;

Step six: once the owner has been fully paid, all profit is available for the employees.

In this way the owner can exit the business, and the employees can take control but without having to come up with the money to buy shares.

Some rules

The EOT is an HMRC approved scheme. This means that there are certain rules. A submission must be made to HMRC in advance of the sale to confirm that these rules have been followed. Some of the rules are as follows.

  • The EOT must have a controlling interest. This means at least 51% of the shares must be sold to the EOT (this leaves lots of options, for example owners retaining a minority shareholding and employees being able to buy shares, known as a ‘hybrid’ scheme)
  • The profit must be distributed by the EOT to the employees ‘broadly equitably’. This means it can be varied by salary, service and hours worked. Performance, however, can NOT be a criteria (this is because the payment is due to being a beneficial owner, not due to the quality of work)
  • The amount paid for the shares by the EOT is determined by an independent valuation. You sell for this figure, or lower – but no higher
  • Profit share payments to the employees are free from income tax up to £3,600 p.a.
  • Payments to the owner from the trust are free from capital gains tax

Tax Free

Yes, you read that last point right! Payments to the owner are free from capital gains tax! So why on earth didn’t I mention that before?

The EOT should not be approached simply for the tax breaks. It requires preparation and planning in order to get a business ready for the owner to exit. The ideal finish to the transition to the EOT is where the owner quietly slips out the side door leaving the business thriving behind them. The focus is therefore on taking time to get a business ready for this day.

If the focus is instead on the capital gains tax exemption, then it is common for the transition to be rushed. In this instance the sale might happen before the management team are fully on board; before the framework of the business to give the employees a voice has bedded in; and before the employees are fully engaged.

Remember, the payments for the value of the business will be coming from profits from a business that you no longer control. It is therefore essential that you take time to prepare the business – and we are talking perhaps at least 18 months.

Employee Owership Trust

The Key Decisions

In order to begin the process of becoming the least important person in the business, the owner needs to start considering five key areas:

  • Transference of control
  • The voice of the employees in decision making
  • How to share business information with employees
  • How to share reward with employees
  • Employee behaviours that are expected in return for making them owners in the business

The answers to these five questions lay down the foundations for how the business will change as it moves into an EOT model.

Specific issues that will come up over the course of transition (which is likely to take years, not months) will include: who will be the trustees; the role of the founder; pathways of control; how to align the purpose of the individuals with the purpose of the business; how the marketing and branding reflect the purpose of the business; new leadership styles; how to manage expectations of the existing leadership team.

These are not issues that are always easy to answer. They are the issues that we go through in the Eternal Business Programme.

Who to speak to next

It might be tempting for an owner to speak to their accountant or solicitor to get more information. I would, however, urge caution here.

In truth, there is little tax based input required. The issues are the cultural change required, not something accountants typically get involved with.

Owners will certainly require legal input. There will be lots to do with regards the sale, such as the Sale & Purchase Agreement itself, and many, many other supporting documents. In general, however, this input will be needed at the end of the process, not at the beginning. Don’t go paying fees to your solicitor before it is necessary.

Speak to your Boardroom Advisor, who should have a working knowledge of the EOT. They will get in contact with us if this seems like a feasible option and we can then provide advice on the next steps.

Conclusion

If the business is given the time to get ready in the ways this paper has outlined, then when the sale to the EOT happens, both owners and employees can get all that they want from the transition.

For the owner, they get:

  • A fair value for their business
  • The employees looked after
  • The business continues so that the clients are care for in the same way as currently
  • To leave a legacy

For the employees, they get:

  • A say in the running of the company
  • Access to the profit of the company
  • Clarity over their future

And a last word – do something. The best time to start working on your exit is several years before you actually intend to exit.

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