Planning a business succession can be a complex and emotional process. Passing on the reins of a business that may have been built over decades requires care, thought and planning to ensure its legacy and future success.
One increasingly popular option among business owners is employee ownership trusts (EOTs), a unique model of employee ownership that offers both financial and non-financial benefits to all involved.
In today’s post, we’ll explore what EOTs, how they work, and why they might be the perfect solution for business owners who don’t want to sell up to external investors or larger corporations.
What is an employee ownership trust?
An EOT is a trust structure that allows a company’s employees to own a significant portion of the business, typically through the purchase of shares. It’s a creative alternative to traditional business succession strategies, such as selling to a third party or passing the business on to family members.
The key difference between an EOT and other forms of employee ownership (like direct shareholding) is that employees do not directly own the shares. Instead, the trust acts as the shareholder, and the employees benefit from bonuses (exempt from income tax but not National Insurance contributions) and, in some cases, voting rights.
How does an EOT work?
To create an EOT, a business owner typically transfers a majority (at least 51%) of the company’s shares to the trust through a sale or transfer. The trust will then oversee the company’s operations, ensuring the employees’ interests are considered and distributing any benefits arising from the company’s success.
The process will typically require a business valuation, determining the price of the shares sold to the trust. Once the transfer is complete, you, as the business owner, may choose to exit the business or continue to play an active role in its management. Ultimately, EOTs are designed to be flexible and work out an arrangement that works for all stakeholders.
Very specifically, to qualify as an EOT, the following must apply:
- The company transferring its shares must be a trading company or the principal company of a trading group.
- The EOT must meet the “all-employee benefit requirement”. In other words, it cannot skew benefits to particular employees (see below).
- The EOT must not hold a controlling interest of more than 50% in the company. After the transfer, it must control at least 51% of the company.
- Where the person transferring their shares owns 5% or more in the company, the number of employees who hold 5% or more of shares must not exceed two-fifths of the workforce.
Tax benefits of EOTs
One of the most appealing aspects of EOTs is the financial incentives available to business owners. First, the sale of shares will be free from capital gains tax, levied on any profit made on assets above a certain value (£3,000 in 2024/25).
In addition, bonuses paid out to employees majority-owned by an EOT are exempt from income tax but not National Insurance. While this won’t benefit you as the seller, it could be used as a benefit to persuade employees to opt into an EOT in the first place.
To qualify for tax relief, all employees must be eligible for bonuses and entitled to them on equal terms (although factors like hours worked can determine them). A maximum of £3,600 income tax-free bonus per employee per tax year.
Good practices for EOT transfer and management
Before proceeding with the transfer of shares to an EOT, you need to value the business. The best route to go down is to always enlist the help of a financial expert to ensure that your shares are sold at a fair price. A valuation will also help you decide whether to sell your shares outright or over time.
But above all, strong communication with your employees is paramount. They need to understand how the transition will affect them, how the ownership model works, and what benefits are available.
It’s also important to motivate your employees and get them excited about the prospect of being owners-in-trust. Training, participation, and fostering a culture of ownership can help drive the business’s long-term success.
EOTs can be a great tool for business succession planning. If you’d like to learn more about them or need help arranging one, get in touch with us. Let’s see how we can help.
