If you’re thinking about stepping back from your business, you’ve probably started looking at your succession options. One route that’s become increasingly popular in recent years – especially against the backdrop of reduced capital gains tax allowances – is EOT.
An Employee Ownership Trust (EOT) allows business owners to sell a controlling interest to a trust set up for employees. Not only is it a very tax-efficient option, but it also helps to preserve the company’s culture and secure long-term continuity.
In this blog, we’ll explain how this works in more detail. For one-to-one advice on setting up an EOT, contact Butt Miller. We can offer expert guidance on both succession and estate planning, to help you make the most of your financial assets now and in the future.
What is an Employee Ownership Trust (EOT)?
An Employee Ownership Trust is a structure in which business owners sell a controlling interest – at least 51% of the company’s shares – to an employee benefit trust, i.e. the EOT. The EOT becomes the majority shareholder, meaning it holds the shares on behalf of the employees.
An EOT’s purpose is to give employees a stake in the business’s future, to encourage long-term engagement, business continuity and sustainable growth.
It has been around for some time, but it was formalised and given a specific tax treatment under the Finance Act 2014. Inspired in part by the John Lewis model, EOTs are now a mainstream consideration for many business owners considering succession planning.
How does an EOT work in succession planning?
In practice, the EOT model involves the current shareholders selling the company – typically at full market value – to the trust. This effectively transfers ownership to the employees, who become co-owners through the trust. The business continues to operate in the same way, with the existing leadership team or a newly appointed management team running day-to-day operations.
This structure allows employees to share in the success of the business, while the owners receive deferred consideration over time.
The business finances the acquisition through anticipated future profits, which are allocated to repay the previous owners over time. This approach not only facilitates a smooth transition but also allows for a phased integration process. This can significantly minimise disruption and maintain a seamless experience for customers, employees, and suppliers.
The EOT structure works particularly well when the business already has a capable management team in place – people who know the company inside out and are well-placed to drive it forward. However, it’s vital to consider how to motivate and incentivise these employees, particularly if they will be taking on more responsibility post-sale.
Benefits of using an EOT in succession planning
Tax efficiency
One of the biggest benefits (to you as the business owner) of setting up an EOT is tax saving.
That is because, if you sell your shares through an EOT, you can avoid capital gains tax, as long as these conditions are met:
- The business needs to be a trading company or a holding company of a trading group.
- The EOT must take on a controlling interest, which means it should own more than 50% of the ordinary shares, voting rights, and profit entitlement.
- The company shouldn’t have been owned by employees in the past.
- The EOT should be structured to benefit all employees equally, although bonuses can differ based on factors like pay, hours worked, or length of service.
- After the sale, no more than 40% of the workforce can be made up of employees who also hold shares or are related to shareholders.
As well as the significant tax savings, you might receive payments over time from the company’s profits, which can ease any financial pressure on the management team, allowing for a smoother transition without the stress of securing funding.
Greater employee engagement
From the employee perspective, ownership – albeit indirect – can be a powerful motivator. Employees become more engaged, invested in the company’s success, and aligned with its long-term goals.
Under the EOT model, employees are also eligible for annual bonuses of up to £3,600 free of income tax. In the interest of transparency and fairness, the value of each bonus can be flexible, based on salary, length of service, or hours worked, for example.
Long-term stability and legacy
As a business owner, you’ve put years of hard work into building something that lasts—so it’s only natural to want that success to carry on after you step back.
An EOT can help protect your legacy, preserve company culture, avoid the upheaval of a trade sale, and ensure the business continues in the same way.
By keeping ownership within the company and maintaining the existing leadership team, an EOT can support a smooth transition and provide reassurance to clients and suppliers, as well as employees.
Drawbacks of using an EOT in succession planning
Impact on key management
For an EOT to be successful, your management teams must be fully on side and motivated. If their own career or personal goals don’t align with the EOT structure, their commitment may dwindle, and the business suffers as a result.
A period of careful planning is essential to ensure managers feel valued and incentivised. This might include offering them the opportunity to hold a minority shareholding outside the trust or structuring deferred consideration in a way that reflects their contributions.
Complex setup and legal requirements
Setting up an EOT is far from straightforward. It requires detailed planning and a precise understanding of the tax and legal implications. For that reason, the help of experienced advisers is highly advised. You will also need to employ specialist solicitors to draft trust documentation, employee communications, and sale agreements.
Although the long-term tax benefits are significant, the initial cost and administrative burden should not be underestimated.
Suitability and cultural fit
An EOT isn’t the right fit for every business. It is most successful when there is a strong culture of collaboration and shared responsibility. If the company’s ethos does not align with the principles of employee ownership, or if the trustees are not empowered to act in the best interests of employees, the structure can become a burden rather than a benefit.
Before proceeding, it’s important to assess whether the EOT model supports the company’s long-term succession plan and is compatible with its culture and values.
Not always the most profitable route
Although the capital gains tax exemption is compelling, a trade sale to a third party may still result in a higher net return to the owners – particularly if a premium price is achievable. The decision should not be driven by tax advantages alone.
Other options, such as a management buyout (MBO), might also offer a better fit. An MBO allows the key management team to take ownership of the business and may better align with their personal goals. It typically involves an initial cash payment – using surplus company funds – followed by deferred payments from future profits.
Limited liquidity for employees
Under the EOT structure, employees don’t hold shares directly. While they can benefit from an annual bonus and a share in the profits, they do not have the same opportunity to build capital wealth as they might through direct share ownership.
One possible solution is to allow members of the management team to hold up to 49% of shares outside the trust, either before or alongside the creation of the EOT. Mechanisms can also be put in place to create a market for those shares – such as buyback arrangements for ‘good leavers’ – ensuring fairness and flexibility in the long term.
Are there alternatives to EOTs?
EOTs are just one of several succession planning tools available. A trade sale to an external buyer is a more traditional route, although it can be time-consuming, disruptive, and subject to post-sale restructuring.
Another alternative is for the existing leadership team to create a new company that purchases the business – essentially an MBO by another name. This can offer greater flexibility for all parties and may be more appropriate in businesses with fewer employees or a highly capable leadership team.
Ultimately, the right solution depends on the goals of the owners, the aspirations of the management team, the nature of the business, and the overall market conditions.
Looking for exit planning advice? Get in touch with Butt Miller
At Butt Miller, we work closely with business owners to help them explore their options and execute a succession strategy that’s right for them. Whether you’re considering an Employee Ownership Trust, a management buyout, or a trade sale, our team of professional advisers can guide you through the process with clarity and confidence.
If you’re thinking about succession planning or have questions about tax-efficient exit routes, we’d be delighted to help. Get in touch today to arrange a consultation.
