Why Employee Ownership Trusts are an attractive option in 2023: Continuity, Culture and Cash

Authors: Nick Betteridge and Holly Bedford

An Employee Ownership Trust (EOT) is a Trust established for the long-term benefit of the employees. Selling a business to an EOT is an increasingly popular exit route for business owners.

Research from the Employee Ownership Association and the White Rose Centre for Employee Ownership shows a steady increase in the number of new Employee Owned Businesses (EOBs) in recent years with a 37% increase in EOBs in the last 12 months alone – almost all of these conversions to employee ownership involved an EOT to facilitate business succession. The research highlights that there were 1,418 EOBs in the UK as at June 2023. This represents a rise of 388 EOBs in just 12 months, and we expect this upward trend to continue.

Selling to an EOT provides advantages over traditional exit routes, including staying in control of the sale process, lower advisory costs, confidentiality and a tax-free sale. Going forward the employees have a significant financial interest and often also a voice in the business, which is good for recruitment and retention.

The current economic environment is likely to encourage more EOT sales. The press is full of stories about the perilous state of the UK economy with sticky inflation, increasing interest rates as the Bank of England navigates a possible recession, chronic labour shortages and a floundering Tory party with Labour as the government-in-waiting.

An unsettled economic landscape
Following a recent period of economic volatility, the economic outlook remains fragile and growth is still expected to remain weak with maintained high interest rates in the medium term.

Many business owners, exhausted from working through Covid and braced for further challenging conditions may conclude that now is the ideal time to retire, but they will be faced with the realisation that a suitable buyer may not be easy to find.

Not a seller’s market?
Traditional buyers may be more cautious than usual due to economic uncertainty and high interest rates, which magnify the usual risks associated with acquisitions. Combined with this, current difficulties in debt markets may make third party transactions harder to achieve at present, the usual financing options may not be readily available.

Although EOT sales can also be funded by third party debt, the seller shareholders often simply defer a large portion of their proceeds to be repaid over time from future company profits, without involving external debt. This means that EOT sales do not rely on the availability of reasonably priced third-party debt and so they can proceed, even in the current environment.

EOT sales provide an even keel
Third party sales create significant disruption and, in practice, may lead to reorganisation and job cuts to maximise efficiencies. The fear of change, new management and job cuts can reduce employee morale. In the current tight labour market, valuable employees could decide to jump before they are pushed. Many owner-managed companies have loyal employees, and the owners are keen to ensure their employees are well looked after post-sale.

Conversely, the enduring structure of EOTs provides continuity of culture and conditions and a greater sense of job security. The existing business owners can remain on the company board and/or be on the EOT board, resulting in a seamless transition with minimal disruption to the day-to-day running of the business. Employees do not need to fear change or redundancy and they also gain a sense of ownership that they may not have had before which can spur their motivation and engagement.

Recruitment and retention
EOT trustees are required to act in the employees’ best interests. This alignment of objectives has been proven to improve job satisfaction and overall company performance. EOTs are proven to improve productivity, reduce absenteeism and develop more engaged employees.

Employees also have the potential for significant future payments as profit share or if the trustees decide to sell the business at a later stage. In the case of a sale post-EOT, the capital sum would be distributed amongst all of the employees. There are strict fairness principles to follow, however, the trustees do have the power and flexibility to differentiate between different employees, based on three factors – length of service, working hours and salary.

These factors often see retention rates and career progression enhanced post-EOT, enabling the business to attract the most skilled and ambitious employees in their industry.

It is also possible to run bonus or share incentive schemes to continue incentivising senior management alongside the EOT.

A changing tax landscape?
The UK is already a high-tax economy with the overall tax burden hitting record levels. Labour governments are usually less sympathetic to unearned income and support higher tax rates on capital gains and savings. With a requirement to service huge levels of government debt, at higher interest rates alongside crumbling public services, a future Labour government could well look to those with “broad shoulders” to pay higher CGT rates which will make the benefits of an EOT sale more noticeable.

The EOTs rules may change as a result of the Employee Ownership consultations recently announced. The consultation is seeking to shed light “on the use and effectiveness” of EOTs to ensure that the tax regime is targeted at incentivising employee ownership “whilst preventing the reliefs from being used for unintended tax planning”.

Overall, EOTs are doubling year on year and are proving to be a favourable option for business owners wishing to exit and may become even more prevalent, due to the current economic climate and difficulties in the debt markets.

EOTs can provide a continuation of a company’s established culture and strategic management, compared with the more volatile changes that third party sales can involve. An EOT also provides incentives such as increased employee involvement and the employee bonus scheme which can encourage team members to remain and new employees to join the business. These benefits are on top of the attractive transactional and tax benefits to the selling shareholders.

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