Advantages and disadvantages of Employee Ownership Trusts

Jan 16, 2025 | Uncategorized

Employee Ownership Trusts (EOTs) are gaining traction as businesses explore new ways to engage employees and secure long-term stability. For those looking to pass the baton without selling to a competitor or external investor, EOTs present a compelling alternative. But, as with any business structure, they come with their own set of pros and cons. Here, we break down the essentials to help you decide if this model might work for your business.

 

What is an Employee Ownership Trust (EOT)?

An EOT is a structure that enables employees to collectively own a company. Introduced in 2014, the model was designed to encourage employee ownership, improve company performance, and provide tax benefits. When a business owner sells their shares to an EOT, those shares are held in trust for the benefit of employees.

Unlike direct employee share ownership, employees do not individually purchase shares. Instead, the trust owns the business, and employees indirectly benefit from its success. This can create a strong sense of shared responsibility and long-term engagement.

 

How does it work?

The process typically involves the following steps:

  1. Valuation: The business is valued to determine a fair share price.
  2. Trust formation: A trust is set up to acquire the shares on behalf of employees.
  3. Financing: The EOT often uses a mix of bank loans, deferred payments from the selling owner, or company profits to fund the purchase.
  4. Ownership transfer: The selling owner’s shares are transferred to the trust.
  5. Employee benefit: Profits are reinvested or distributed to employees through bonuses, fostering engagement and shared interest.

 

The benefits of EOTs

Tax incentives

One of the most attractive elements of EOTs is the tax benefit. Business owners selling a controlling interest (at least 51%) to an EOT are exempt from Capital Gains Tax (CGT). Additionally, the company can pay annual tax-free bonuses of up to £3,600 per employee.

 

Employee engagement and retention

Studies show that employee-owned businesses often outperform their peers in productivity and employee satisfaction. With employees having a vested interest in the company’s success, turnover tends to drop, and innovation improves.

 

Legacy and stability

EOTs ensure continuity for owners who want to secure the future of their business without selling to a competitor. This model can help retain the company’s culture and values, safeguarding its legacy.

 

Potential downsides of EOTs

Financing challenges

Funding the purchase of shares can be complex. Not all businesses have the reserves to finance an EOT internally, and relying on bank loans introduces additional risks.

 

Employee understanding

While the model aims to engage employees, not all staff may fully understand or appreciate the structure. Clear communication and ongoing education are essential to ensure employees see the value in the model.

 

Profit pressure

If profits are needed to repay loans or fund the trust, less capital may be available for business growth or investment. This can place strain on the business, particularly in the early years.

 

Key steps for setting up an EOT

  1. Initial assessment: Consider if the business is suited to the EOT model. Stable profits and a strong workforce are helpful indicators.
  2. Valuation and structuring: Engage with legal and financial advisors to conduct a valuation and design the trust’s structure.
  3. Establish the trust: Form the trust and appoint trustees. This often includes independent and employee-representative trustees.
  4. Financing the purchase: Determine how the EOT will finance the acquisition of shares.
  5. Communication and engagement: Inform employees, explaining the benefits and their role in the new structure.
  6. Transfer and ongoing management: Transfer ownership and establish processes for future governance and profit-sharing.

 

Is an EOT right for your business?

EOTs aren’t a one-size-fits-all solution, but they offer a pathway to secure succession planning, improve employee morale, and unlock tax efficiencies. The key lies in thorough planning and clear communication. EOTs can foster long-term growth and stability if structured correctly while protecting the business’s identity and values.

If you’re considering an EOT or want to discuss how this model could work for your company, get in touch with Langdowns DFK. We’re here to explain the advantages of employee ownership trusts, guide you through each step, and ensure a smooth transition.

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