Employee Ownership Trusts

Have you ever considered selling your business to your employees? Are you aware of employee ownership trusts?

I wish I could sell my business, make sure my employees are looked after and make sure the business continues in the same spirit as before. It might be hard to believe, but our office of tax professionals is a fun place and I would like the fun to continue. I would like my team even after my demise to have a joke and take on clients and work they enjoy working with.

I dislike the thought of a practice acquiring my business that then sets chargeable hours and recovery of work in progress objectives. I prefer the thought of my team striving to do better for our clients rather than specifically aiming to charge more (that doesn’t mean we don’t charge!).

Who can I sell to? We are not designed to fit in with another practice and therefore if we are taken over, the business will face change. A concern is then that the team I work with may experience what I had to endure at the Big 4. I accept working at the Big 4 is technically great.

However, the rivalry to succeed amongst peers is not. It generally meant recording time, billing time, winning big fee work and forcing your way to be recognised as superior. I am competitive but I compete to do better than I did before, I don’t want to forcefully compete with colleagues. So am I doomed, when it comes to selling my business?

The most sensible choice would be to sell my business to my management team or employees (should they want it). The value of the shares may make it problematic for senior management to acquire them. There are options available to structure an exit including company purchase of own shares and a vendor initiated management buyout (‘VIMBO’). Another option avoiding private equity and venture capitalist includes the employee ownership trust (‘EOT’). The shares are owned by a trust collectively for the long term benefit of the employees as a whole.

Selling shares to an employee ownership trust

Finance Act 2014 Schedule 37 permits the owners of a company to sell their shares tax-free to an employee ownership trust. The sale must be for the majority of the shares so that the company becomes owned and controlled by the employee ownership trust. A vendor might be able to benefit from business asset disposal relief on a conventional sale and only have a 10% tax liability on the gain (up to a gain of £1m). Whilst a tax-free sale may be attractive, it is likely other factors will influence an employee ownership trust ownership structure.

An employee ownership trust is unlikely to have funds with which to buy shares. The purchase consideration is ultimately being funded from future earnings of the company.  Future earnings that otherwise might have been taxed as income can be released from the business without income tax or National Insurance. This sounds attractive although the vendor will need to be confident the business will perform in order to fund their exit.

The company could lend to the employee ownership trust to finance the purchase.  Lending can trigger tax liabilities under the loans to participators rules. Where the company does have adequate funds a company purchase of own shares and/or a mix of enterprise management incentives, share schemes, VIMBO  and employee ownership trust may provide more options.

Once a company has become majority-owned by an employee ownership trust it is not easy to reverse the structure because the trustees have to act in the long-term and best interest of employees as a whole.

There are many non-tax issues that ought to be considered including:

• Who will be the trustees?
• How are trustees appointed?
• If a corporate trustee is used (normal), who forms the corporate trustee board?
• Usually independent directors are appointed to a trustee board, who should these be?
• What influence will employees have?
• Will an employee council be created to advise and appoint employee trustee directors?
• Should key commercial decision be referred to employees?
• Should employees have a vote in respect of a future sale?

Another advantage of Schedule 37 is that up to 49% of the shares can remain in direct ownership. Whilst this is not a controlling interest, it is likely to be very influential at shareholder level.

As mentioned above, hybrid schemes (a mix of employee ownership trust ownership with direct shareholdings and or options over shares) can appear to offer the best of both worlds. A hybrid structure may result in the company to implement control by indirect employee ownership while allowing individuals to have direct equity participation.

However, if share options or new shares are issued the company needs to be careful that the employee ownership trust’s holding is not diluted below 51%. This could trigger clawbacks or other tax charges.

Schedule 37 also provides another benefit: The company can pay tax-free annual cash bonuses up to £3,600 per employee. The cash bonus is not a dividend, and can be paid without the company having to make a profit or have distributable reserves.

The employee ownership trust-owned company legislation does not prevent anti avoidance legislation applying to transactions in securities. The funding of consideration paid by the employee ownership trust from future earnings could potentially create an exposure under this legislation. It is prudent to seek advance clearance from HMRC that the transactions in securities provisions will not apply.

HMRC are likely to provide clearance if the intentions is to create a genuine employee-owned company although the request for clearance will need to carefully explain the intended transactions. Employee ownership trusts have grown in popularity and this is likely to continue. The employee ownership trust appears to appeal to smaller professional service firms and businesses which need to retain good quality employees.

To obtain the tax advantages, an employee ownership trust must:

• Hold a controlling interest in the company
• Be established for the benefit of all employees (excluding, broadly, individuals who hold or have previously held 5% of the shares)
• Treat all employees on an equitable basis

An EOT may be appropriate if you are:

• Looking to exit from a business you own
• Starting a new business and want to attract key employees
• Keen to give employees a stake

You are also likely to want to ensure your business can stay independent. As mentioned there are many options, including company purchase of own shares and a VIMBO. The options may also be ‘hybrid’ and include enterprise management incentive

If you would like to discuss how we can help please get in touch

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