Employee Ownership Trusts – not just a corporate transaction
The number of transactions involving the sale to an Employee Ownership Trust in the UK increased dramatically in 2021 and, at Geldards, we are seeing a continuation in demand with new enquiries and instructions to advise on EOTs.
What are EOTs?
An EOT is a trust created for the benefit of the employees of the company. The trust will have trustees who will own the shares in the company on behalf of the employees and “look after” the shares in the best interests of the employees.
The EOT will buy the shares from the selling shareholders and the EOT must have a controlling interest in the company, meaning at least 51% of the shares. In many cases the EOT buys all the shares in the company although, in more limited cases, the shareholders may retain a minority shareholding.
The selling shareholders may not receive all the consideration for the shares on completion; an initial lump sum will be paid with the remainder of the consideration being paid over a number of years out of the profits generated by the company.
The selling shareholders are taking a substantial risk that the company will be able to generate the profits. This is a key difference from a “trade sale” to a third party or a sale to the management team (a “MBO”) where a large proportion, if not all, of the consideration will be paid on completion.
See our article on Employee Ownership Trusts: A new company ownership model to see why EOTs have risen in popularity in recent years.
Why sell to an EOT?
In many cases, the selling shareholders wish to protect their business legacy having spent many years building up the company from scratch. The founders may not have family members who are either willing or have the business skills to take on the ownership and running of the company. The founders will have a paternalistic approach to their staff and want to keep the jobs in the local area.
A trade sale or even a MBO provides no guarantee that the buyer will keep the business going in the same locality or will not make cost savings by making staff redundant because the roles are replicated in the buyer’s existing business.
The tax benefits for the selling shareholders can also be a factor. A sale to an EOT is free of capital gains tax (“CGT”) provided all the qualifying conditions are satisfied. This compares to a trade sale where the first £1m may be subject to CGT at 10% and the balance subject to 20% CGT. The tax saving on a sale to an EOT for £5m is £900,000. The tax saving may mean that the selling shareholders can sell for a slightly lower price or are prepared to wait longer to receive the consideration.
A normal corporate transaction?
The increase in popularity of sales to EOTs may make legal advisers think the EOT transaction is just like a normal sale without the aggravation of hotly contested sale documentation and lengthy disclosure of information about the company. However, this is a misconception as a sale to an EOT raises a host of other issues which require a different skill set and, dare we say it, mindset for corporate lawyers.
The problems we have come across when advising EOTs that have gone through the sale process include:
- Little or no employee engagement; the employees may not even know the sale has taken place or even if they know it has happened, what it means for them. This is a huge opportunity missed – the sale to an EOT should be seen as a “good thing” for the employees in terms of job preservation and the opportunity for increased rewards in the future.
- The founder not stepping back and allowing an element of control to pass to the management team; everything continues as before other than the founder has taken a large amount of money from the company on a tax free basis.
- The trust (via the trustees) not being allowed to exercise its right as the shareholder to exercise an oversight role in relation to the business – linked to the founder not giving up control.
- The sale documentation is prepared heavily in favour of the selling shareholders with the trust (or the trustees) having no real idea of what they have signed up to or their responsibilities and obligations. In one case, we came across an interest rate of almost 11% APR on the deferred consideration with no repayment for five years (effectively creating an additional payment approaching £500,000 which would have been subject to income tax in the hands of the selling shareholder).
- The company valuation being prepared for the selling shareholders with no independent valuation for the trustees, with the result that the trustees cannot be sure that they have not agreed to overpay for the shares.
Points to take away
A sale to an EOT can seem very straightforward and very tax beneficial for the selling shareholders. However, in our experience, a successful sale to an EOT requires much more than a good corporate lawyer.
Here at Geldards, we can help guide you through the process from start to finish. If you are thinking about a sale to an EOT or if you have clients who you think would be interested, please do not hesitate to contact us below for an initial chat.
“Geldards have proved to be invaluable whilst guiding us through the employee ownership transition. We have been reassured throughout the process by Geldards’ professionalism and competence. I would recommend them to anyone contemplating an EOT.” – Bruce Bollington, Lorax