An employee ownership trust (EOT) is a legal structure that allows a company to be owned by employees that collectively own the majority state (usually more than 50%) in the business through a trust. To set up, the EOT needs a board of trustees and the structure can offer significant tax advantages when owners come to sell, including the potential exemption of Capital Gains Tax.
Pros of employee ownership trusts:
- Employee engagement and motivation
- Tax benefits
- Business continuity
- Shared ownership and wealth distribution
- Access to finance
Cons of employee ownership trusts
- Complexity and setup costs
- Governance challenges
- Limited liquidity
- Ownership dilution
- Cultural shift
- Potential for conflicts of interest
This article explains the common employee ownership trust problems and advantages to help decide if it is the correct business ownership structure for your business to consider.
Pros of Employee Ownership Trusts
This method of ownership can offer plenty of advantages for businesses including;
Potential Tax Advantages
A major benefit of employee ownership trusts is the tax advantage to both the company and its employees. The benefits become obvious When you consider the rising VAT rates and National Insurance.
An employee ownership trust makes the company eligible to claim a deduction for amounts paid into the trust. Similarly, the employees do not have to pay income tax or capital gains on any shares they get from the trust.
A Ready-Made Buyer
An employee ownership trust can function as a ready-made buyer for when you want to sell a business but don’t want the stress of finding a buyer. A trust becomes beneficial in such a scenario and helps to smooth the transition phase for employees.
With an employee ownership trust, there is no need to worry about the continuity of the business or how the business remains in the local community. The legal framework of the trust covers all that. This is a very important advantage of employee ownership trust considering how difficult it is to find a buyer who is willing to keep the business in the same area and maintain employment levels.
The Opportunity to Plan Succession
Moving on or retiring from a company is easier with an employee ownership trust. You can smoothly plan your succession since the trust allows you to sell your shares at a discount. The money realised can then be used to fund your retirement.
It is a great model to ensure the proper care of all employees and that the business continues no matter who quits. Another advantage of employee trust is how the structure enables employees to leave the business in the hands of a trusted individual while remaining a significant part of the business operations.
The company can decide to choose a successor a few years in advance to allow them to properly transition into their new role. It gives room to grow and develop before taking charge of the trust.
The Best Price for the Business
Businesses interested in selling their assets to an employee ownership trust can be certain to negotiate a fair price. That is because the trust provides a discount on the shares that goes into offsetting any tax liabilities.
There is also room for negotiation on the most convenient payment plan for your business. The joint objective is agreeing on terms that keep the business running smoothly during the transition period. An employee trust model ensures fair business negotiations that would not force you to sell below market valuation.
Various Employee Benefits
An added advantage of employee ownership trusts is their employee benefit offers. These contain the protection of employee shares in the company and ensure fair profit-sharing schemes.
It creates a work environment that motivates staff and proves the company has their best interests. Some trusts even offer the employees a chance to contribute to how the business is run and a diverse workplace where every contribution is important.
More Chance of Attracting and Retaining the Best Talent
Companies that set up employee ownership trusts have a higher chance of attracting and retaining the best talents. Most applicants will accept an offer from such companies because of how they provide their employees with attractive benefits packages and the opportunity to own shares in the company. It is a massive advantage especially when scouting the best talents in a competitive industry.
The Opportunity to Stay Involved in the Business
You enjoy the opportunity to stay involved in the business operations when you sell your company to an employee ownership trust. They could either accept you as a business consultant or grant you a seat on the board of directors.
It is part of the continuity plan of the employee trust model to ensure the business keeps running smoothly. You also retain the right to contribute your expertise and suggest how the business is run. This is an excellent idea for business owners who have to sell their business but still want to remain passionate about it.
Cons of Employee Ownership Trusts
Is it possible for an employee ownership trust to go wrong? Learn about the potential disadvantages of employee ownership trusts and how they might impact the decision of whether the trust model is the right choice for your business.
A Difficult Process
A significant disadvantage of employee ownership trust is the difficulty in setting them up. The process can be quite rigid, particularly having to find a trustee who is also willing to take responsibility for running the trust.
The next stage is a time-consuming and complex process of transferring your shares to that trust. The eventual success of the transfer of ownership depends on the set-up process and the respective involvements of everyone.
Each employee must understand their roles and responsibilities. Consider seeking professional help from a business lawyer if uncertain about any part of the process.
Problems Getting the Money Upfront
Another potential disadvantage of employee ownership trusts is the challenge of raising enough cash upfront to pay for the shares. The process of sourcing funds is time-consuming and you might have to opt for a loan or raise capital from investors which is difficult. Many financial institutions might be unwilling to release much capital to a complex handing-over process.
The Trust will be In Control
Having trust in control of the business is a downside of employee ownership trusts. As the business owner, you lose some control to the trustee and they have a greater input in decision-making processes.
This change in business style is going to be difficult for those business managers who are used to dictating the order of daily business operations. The only solution is maintaining a smooth working relationship with the trustee board. You might be able to negotiate some business decisions in your favour by staying close and letting them see things from your perspective.
Complications with Taxes
Several complications with taxes might arise with setting up an employee ownership trust in your company. These include changes to tax reliefs, capital gains tax and stamp duty.
You should consider contacting HMRC or a qualified lawyer to explain the implications of the transition on your taxation process. Otherwise, it is possible to unknowingly breach certain tax compliance laws or even default on certain payments.
How to Set Up an Employee Ownership Trust
Learn how to set up an employee ownership trust without complicating your taxation process.
Find a trustee – this can be the most challenging part of setting up an employee ownership trust. You need to find someone who is willing to function as the trustee of the trust. The person will be responsible for the smooth running of the trust and oversee the essential decision-making processes. The trustee also ensures compliance with relevant regulations especially immediately after the transition process.
Transfer your shares – the net process is transferring your shares to the trust once you have found a trustee who is willing to take over. The transfer process is sometimes complicated and we advise you to get professional help to avoid legal issues down the line.
The common complication with the transfer of shares to an employee ownership trust is understanding the extra capital gains tax to pay when there is an increase in value after the acquisition
Set up the trust – setting up the trust should happen immediately after you transfer your shares. The process involves drafting a trust deed and registering it with the appropriate authorities. You also need to oversee the appointment of a board of directors that will monitor the running of the trust and ensure continuity in business operations.
Register with HMRC – proceed to register the employee ownership trust with HMRC after selecting its board of directors. It is an important process that makes the trust recognised as a legal entity by HMRC and helps them understand the correct tax rules to apply to the trust. Failure to register early can attract fines and stipulated penalties.
Operate the trust – you need to set up the trust to operate under binding rules and regulations. That includes enlightening the board members of the trust and employees on their respective roles toward the smooth running of the business.
The trustees must comply with stated laws and should not engage in illegal activities or submit inaccurate reports to HMRC or local authorities. There must also be a proper record-keeping process for all transactions carried out by the trust.
The overall process of setting up an employee ownership trust is complex and time-consuming most times but there is plenty of help available to navigate the twists and turns.
Rules that Govern Employee Ownership Trusts
Learn about the important rules that govern employee ownership trusts. A perfect understanding of these rules is necessary for full compliance.
- The employee ownership trust must have a written trust deed with clearly stated rules and regulations that bind its operations.
- The trust must have a minimum of five trustees to guarantee effective management of the business.
- Every board member of the trust must be independent of the company to prevent conflicts of interest.
- The employee ownership trust must be registered with HMRC for it to apply the correct tax rates to the business.
- Every trustee must meet the stated minimum qualifications and should be enlightened about their respective roles to oversee the proper management of the trust.
- Trustees must always act in the best interests of the beneficiaries.
- The trust must have a clear purpose, such as employee ownership or employee participation.
Alternatives to Employee Ownership Trusts
There are other alternatives to employee ownership trusts for consideration if you want a different business set-up. They include:
- Selling the business to a third party – this is the most common method of transferring the ownership of a business. The reason for its popularity is how you get the full market value for your business. You also get to retire completely which could be a disadvantage for people who want to stay involved in the business.
- Selling the business to employees – this is a similar strategy to an employee ownership trust except that you will not remain in the business but will still get reasonable compensation for selling.
- Selling the business to a family member – consider this option if you have a family member interested in taking over the business. You will be selling to them like the other methods but with an extra possibility of remaining in the business if they agree. The only compilation is how to resolve tax payments such as calculating the capital gains tax.
- Setting up a holding company – this technique is for business owners who still want to maintain control over the business without much active involvement. You can sell to a third party that manages the daily operations of the business but remains under your instructions. The only downside is you have to pay tax on any dividend received from the company.
Final Thoughts
It’s important to understand the pros and cons for Employee Ownership Trusts when considering this route for your business. If done well, they can create a shared sense of ownership amongst employees but on the downside they’re complicated to set up and need a strict hand to manage them effectively.
The decision to pursue an EOT or not will need to be led by each business’s goals, culture and appetite for such a shift in its set up.
