This is an article recently posted on LinkedIn by Cathy Cook, Partner of LCF Law and reproduced below with permission.
Anyone keeping an eye on the business pages will have seen that sales to Employee Ownership Trusts (EOTs) are growing in popularity, and are providing a useful way for business owners to exit in an uncertain market or where there is a limited market due to the niche nature of the business. We’re all aware of the partnership model operated by John Lewis and the sale of Aardman Animations (the company behind Wallace and Gromit), but do we really understand what an EOT is and why they are so attractive?
WHAT IS AN EOT?
Essentially an EOT is a unique trust for the benefit of employees, which means that the Company is effectively owned by and for the benefit of the employees. This is often a very attractive proposition in creative or niche technical businesses which might otherwise struggle to find a buyer, and which enable a founding shareholder to exit and hand over control to a competent and deserving management team. If structured correctly to meet the requirements of the tax legislation, using an EOT structure can mean that the selling shareholders pay no Capital Gains Tax on disposal and the employees also gain certain income tax exemptions on the payment of future bonuses. As you might expect, however, there are caveats which include:
- there must be a trading company as part of the sale;
- the sellers must relinquish control in terms of dividend, capital and voting rights;
- any sellers who held 5% of the shares in the Company at any point in the 10 years prior to the sale cannot benefit under the terms of the EOT if they remain with the Company as employees after the sale (this doesn’t affect their CGT position); and
- the selling shareholders and their connected parties must not have comprised more than 2/5th of the overall workforce in the 12 months prior to sale or to the end of the tax year in which the sale takes place (‘the Limited Participation requirement’).
The last of these is designed to ensure that individuals who had a substantial shareholding in the company, and who together with family members and other selling shareholders made up a significant proportion of the business’s workforce before and after the creation of the EOT, cannot benefit from the tax advantages of the EOT.
Points 3 and 4 above will often inadvertently affect individuals who have been structuring their shareholdings for an open market sale, as often shares have been transferred to spouses who are also appointed as officers of the Company to ensure that they qualify for entrepreneur’s relief. If the business is relatively small and also employs other family members of a founding shareholder then it can quickly fall foul of the Limited Participation Requirement.
For the correct businesses EOTs can be extremely successful, but if you think it would work for your business then you do need to take early advice as you may need to do some preparatory restructuring (potentially up to 12 months prior to planned sale) to ensure that you will comply with the rules on exit.
This article was written by Cathy Cook. Cathy is a Partner in the Corporate Department of LCF Law and is based in Leeds.
Her clients include owner managed businesses specifically suppliers into the large retailers for whom she has reviewed and drafted terms and conditions, framework agreements and outsourcing agreements.
You can contact Cathy 01132 384 042 or email ku.oc.fcl@koocc
