Out-Law Analysis 5 min. read
11 Mar 2022, 3:04 pm
Employee ownership trusts (EOTs) are increasingly popular ownership models that can deliver benefits to an organisation’s shareholders and its employees.
However, while EOTs offer a ‘third way’ alternative for shareholders to exit beyond the more common trade sale or an IPO, careful thought is needed over how EOTs are structured and how the sale of shares will be provided for and funded.
An EOT is, broadly, an employee benefit trust established for the benefit of all employees of a company, and that trust then controls the business more generally.
An EOT must meet certain statutory criteria, the chief one being that the EOT must have a controlling interest in the company in question, which means the EOT must hold more than 50% of the share capital and voting rights of the company and be entitled to more than 50% of the profits available for distribution or assets on a winding up.
Through the EOT, each employee effectively becomes joint owner of a majority of shares in the company, in a similar model to that adopted by John Lewis.
EOTs have become a popular ownership model for businesses of a variety of sizes and in multiple sectors since their introduction in 2014. In particular, a number of businesses in the healthcare and childcare sectors have implemented an EOT. This reflects the importance of employees in these people-based businesses and the associated need to address high employee turnover.
For example, Edinburgh-based childcare business Kidzcare, which operates four nurseries and six-after school clubs, is now 100% owned by an EOT. Its founder has said that she could not imagine selling her business to anyone other than her employees.
Another example is Shaw healthcare. It has been EOT-owned since 2020 and ranks as one of the UK’s largest employee-owned companies, using the benefits of an EOT structure in conjunction with wider share incentive arrangements for the benefit of its employees.
But why would a business owner consider this model, and what are the advantages of introducing an EOT?
EOTs can bring multiple benefits. both to the employees of a company and the owner or shareholder looking to sell their shares into the EOT.
While EOTs can be beneficial for the reasons set out, shareholders are also increasingly seeing the sale of all or part of their holdings to an EOT as a viable exit alternative to pursuing a traditional trade sale or an IPO.
There are some particular benefits for shareholders selling to an EOT.
As mentioned previously, no capital gains, income or inheritance tax liabilities arise on the disposal of a controlling interest in a company to an EOT, or on the subsequent receipt of the purchase price by the former shareholders.
Provided the EOT holds a controlling interest in the company, the tax benefits of selling to an EOT will apply, which means shareholders are not required to sell all their shares to the EOT to take advantage of a tax free disposal. This also means not all shareholders are required to sell their shares to the EOT. This can be beneficial if, for example, some shareholders are looking to retire while others wish to maintain their shareholding.
Selling directors can also remain in situ post-disposal and can continue to receive remuneration.
The EOT is generally seen as a “friendlier purchaser”, which means the sale process may be quicker, with potentially lower fees. However, this can mean the purchase price is lower than might be achieved on a traditional trade sale.
There are three important steps. The funding of the purchase is the area that will require the most thought.
A qualifying EOT will be established with a company as the trustee of the EOT.
The shareholders sell their shares to the trustee under a share purchase agreement.
The shareholders and the trustee will usually engage a share valuation expert to value the company and the trustee will use this value as the basis for determining the purchase price. On the sale of the shares, the purchase price will create a debt owed by the trustee to the shareholders. This debt can be discharged in a number of ways.
One option is for the EOT trustee to borrow money from a bank. A bank may demand security over the shares, and/or a company guarantee that it will provide the funds to the trustee to repay the loan.
Another option is for the company to borrow the money from a bank and either loan or gift the money to the EOT. However, this may not be possible depending on the company’s existing debt/financial position and may impact the company’s ability to receive additional debt finance for business purposes, which may not be beneficial.
A third option is for the company to fund the trustee. If the company does not have sufficient funds to pay the purchase price in full, or is unable to obtain funding as above, it is possible for the sellers to agree to receive their consideration on a deferred basis, for example when the company has sufficient cash to make contributions to the EOT for the trustee to repay the outstanding purchase price that it owes. In these circumstances, it is likely that the sellers would want to have some continued involvement in the business while deferred consideration is still payable to them.
The benefits of implementing an EOT are many and varied. However, the structure of the EOT, and the sale of the shares to the EOT need to be carefully considered to allow for the company to function and perform well following the EOTs establishment.
Communications with employees on the implementation of the EOT are also essential to meet the overall objective and purpose of an EOT, which is to build a successful employee share ownership model.
Co-written by Charlotte Nickel of Pinsent Masons.