Sales of businesses to employee ownership trusts (EOTs) are becoming an increasingly popular alternative route for sellers seeking to realise value, benefit from certain tax advantages and further incentivise employees.

 

In this overview, we explore: (i) the background to EOTs and (ii) certain key legal components of these structures.

 

Background to Employee Ownership Trusts

 

An employee ownership trust is a Government initiative designed to encourage employee ownership.

 

HMRC require that employees have a “significant and meaningful” stake in the business and set out two key tests being:

 

• a financial stake in the business (though by owning shares); and

 

• a say in how the business is run, known as ‘employee engagement’

 

 

Key Legal Components of EOTs

 

Key legal aspects of EOTs include the following:

 

Structure:

 

• Sale to a trust: employee ownership trusts do not consist of direct share ownership by employees but instead involve the sale of a controlling interest to a trust (the beneficial owners of which will be the employees of the company).

 

• Controlling interest: the sellers are required to retain no more than 49% of the shares in the company such that the trust holds a “controlling interest” of 51% or more.

 

• Trustees: typically the trustee is a limited company with the ability for a minority of the directors of the corporate trustee to be representatives of the sellers. The trustees are subject to customary duties to protect the interests of the beneficiaries of the trust (i.e. the employees) including ensuring the value being paid for the shares is reflective of market value (this can include an independent valuation).

 

Consideration:

 

• Structuring: typically this is structured as: (i) an initial payment on completion (which may be funded from existing resources of the company and or third party lending) and (ii) a deferred component (typically funded from the profits of the business).

 

• Funding: the consideration may be funded through the ongoing performance of the company, subject to third party lending (possibly secured against the assets of the company) or a combination of these.

 

Employee participation:

 

• All employee requirement: generally, all employees must be able to benefit from the EOT with certain exceptions. One key example of such an exception is that new joiners who have less than 12 months service can be excluded from benefiting;.

 

• All employee requirement: shareholders or former shareholders (subject to specific time limits) who are employees must be excluded.

 

• Ability to incentivise management: there is the ability to continue to incentivise management and senior employees through equity arrangements for example EMI option schemes.

 

• Governance: consideration needs to be given as to how the company and the EOT will be run on an ongoing basis.

 

• Ease of process: typically, sales to the EOT run in a manner that is easier to manage for the sellers with the lesser pressures on management time in areas such as due diligence (given the familiarity with the business at hand) and an associated reduction in the complexity of warranties and disclosures required.

 

In addition to the above points, there are certain tax advantages to sellers and the company including CGT exemption, income tax savings on bonuses to employees to a defined level and certain corporation tax deductions in relation to such bonuses.

 

Other intangible benefits of the adoption of a EOT can include improving employee engagement and morale to drive retention of key staff.

 

How we can help

Alongside proactive financial and tax support, legal advice  is essential to navigate regulatory landscape connected with EOTs successfully. We can support on a variety of different areas relevant to the sale to an EOT including Corporate aspects and Banking aspects (to the extent third party lending/security is required).

 

For legal guidance and advice tailored to your company’s needs in relation to EOTs, please contact Ben Sims or any member of our Corporate and Banking teams.

While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.