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The Pros & Cons of Employee Ownership Trusts

employee ownership trust problems

An employee ownership trust is a type of employee benefit trust that holds shares on behalf of employees. It is a way for businesses to transfer ownership to employees without triggering a tax liability. The trustees are typically nominated by the company and approved by the employees so that the interests of both are represented.

There are several pros and cons of employee ownership trusts that businesses need to be aware of before deciding whether or not this is the right move for them. In this article, we will explain some common employee ownership trust problems and advantages to help you decide if this is the right business ownership structure for you.

Pros of Employee Ownership Trusts

There are various potential pros of employee ownership trusts that you will need to consider before making the decision to set one up. These advantages include:

Potential Tax Advantages

One of the key benefits of employee ownership trusts is that they offer tax advantages to both the company and the employees. The company can claim a deduction for amounts paid into the trust and the employees do not have to pay income tax or capital gains tax on any shares they receive from the trust. With taxes rising significantly during 2022 including national insurance and VAT, this could be a key benefit for your business and employees alike.

A Ready-Made Buyer

Another advantage of an employee ownership trust is that it can be used as a ready-made buyer for the business. This can be helpful if you want to sell the business but don’t want to go through the process of finding a buyer. The trust can also help smooth out the transition for employees if the business is sold, provide continuity for the business and ensure that the business stays in the local community. This is very important because it can be difficult to find a buyer who is willing to keep the business in the same area and maintain employment levels.

The Opportunity to Plan Succession

If you are looking to retire or move on from the business, an employee ownership trust can help you plan for succession. This is because you can sell your shares to the trust at a discount, which can then be used to fund your retirement. This can be a great way to ensure that the business continues after you have left and that your employees are taken care of. It also means you can leave the business in the hands of someone you trust while still being able to play a role in its operations. You can choose your successor a few years in advance and help them to transition into their new role before setting up the trust with them in charge.

The Best Price for the Business

When you sell your business to an employee ownership trust, you can negotiate a price that is fair for both parties. This is because the trust can offer you a discount on the shares, which can be used to offset any tax liabilities. You can also negotiate a payment plan that suits your needs, which can help to keep the business running smoothly during the transition period. Negotiating a price for a business with a third party often means accepting below-market valuation, this won’t be an issue.

Various Employee Benefits

Another key advantage of employee ownership trusts is that they offer employees benefits. These benefits can include shares in the company, profit-sharing schemes and share options. This can help to motivate staff and show them that there is a bright future for them in the business. You can also offer employees a say in how the business is run, which can help to create a more democratic workplace.

More Chance of Attracting and Retaining the Best Talent

Employee ownership trusts can also make it easier to attract and retain staff. This is because they offer employees an attractive benefits package and the chance to own shares in the company. With more jobs currently available than there are people to fill them, this can be a key advantage when it comes to beating your competitors to the best talent.

The Opportunity to Stay Involved in the Business

If you sell your business to an employee ownership trust, you can stay involved in its operations. This is because you can retain a seat on the board of directors or be a consultant to the business. This can help to ensure that the business continues to run smoothly and that your expertise is used to its full potential. It also means you can still have a say in how the business is run, which can be important if you are passionate about its future.

pros and cons of employee ownership trusts

Cons of Employee Ownership Trusts

Despite all of these benefits, there are also some potential disadvantages of employee ownership trusts that you need to be aware of because they might not be the right option for your business. The main downsides include:

A Difficult Process

One of the key disadvantages of employee ownership trusts is that they can be difficult to set up. This is because you need to find a trustee who is willing to take on the responsibility of running the trust. You also need to transfer your shares to the trust, which can be a complex and time-consuming process. Ultimately, success or failure will mostly come down to how well the trust is set up so that everyone knows their roles and responsibilities. If you are not sure how to do this, seek advice from a business lawyer who will be able to guide you through the process.

Problems Getting the Money Upfront

Another potential downside of employee ownership trusts is that they can be difficult to fund. This is because you need to find the upfront cash to pay for the shares, which can be a challenge if you do not have the money available. You might also need to take out a loan or raise capital from investors, which can be a time-consuming and difficult process.

The Trust will be In Control

When you set up an employee ownership trust, the trustee will be in control of the business. This means they will have the final say on all major decisions, including how to run the business and how to invest its profits. As the owner, you will need to give up a certain amount of control over the business. This can be difficult for some business owners who are used to having complete say over the day to day operations. However, if you have a good working relationship with the trustee, you should be able to negotiate a level of involvement that suits both parties.

Complications with Taxes

There are also some potential complications that can arise from setting up an employee ownership trust. These include changes to tax reliefs, capital gains tax and stamp duty. You will need to seek professional advice to ensure that you are aware of all the implications before setting up an employee ownership trust or you could find yourself in breach of the law.

set up employee ownership trust

How to Set Up an Employee Ownership Trust

If you are thinking of setting up an employee ownership trust, there are a few key steps that you need to follow:

  1. Find a trustee – The first step is to find someone who is willing to act as the trustee of the trust. This person will be responsible for running the trust and making sure that it complies with all the relevant regulations. It is important that you choose the right person or organisation to act as the trustee or you could encounter problems further down the line.
  2. Transfer your shares – Once you have found a trustee, you need to transfer your shares to the trust. This is a complex process and you will need to seek professional advice to ensure that it is done correctly. The main complication with transferring shares is that you will need to pay capital gains tax on any increase in value since you acquired them.
  3. Set up the trust – Once you have transferred your shares, you need to set up the trust itself. This involves drafting a trust deed and registering it with the relevant authorities. You will also need to appoint a board of directors to oversee the running of the trust.
  4. Register with HMRC – Once the trust is set up, you need to register it with HMRC so that they are aware of its existence. This is important as it will enable them to apply the correct tax rules to the trust. If you fail to register within the required timeframe, you could be liable for penalties.
  5. Operate the trust – Once the trust is up and running, you need to operate it in accordance with the law. This includes ensuring that the trustees comply with their duties and that the trust does not engage in any illegal activities. You will also need to keep accurate records of all transactions carried out by the trust.

As you can see, the process for setting up an employee ownership trust is quite complex. However, if you follow the steps outlined above, you should be able to put everything into place without encountering any major issues. If there is anything you are unsure of, it is important to seek professional advice before proceeding.

Rules that Govern Employee Ownership Trusts

There are some important rules that govern employee ownership trusts that you need to be aware of to ensure that you comply with the law. These rules include:

  • The trust must have a written trust deed so that the rules of the trust are set out clearly.
  • The trust must have at least five trustees to ensure that it is properly managed.
  • The trustees must be independent of the company so that there is no conflict of interest.
  • The trust must be registered with HMRC in order to pay the right tax.
  • The trustees must be qualified to do the role so that they are able to properly manage the trust.
  • Trustees must 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 some potentially beneficial alternatives to employee ownership trusts that you may want to consider. These include:

  • Selling the business to a third party – This is the most common way of selling a business. The main advantages are that you will get the full market value for your business and you can retire completely. The main disadvantage is that you will have no involvement in the business once it is sold.
  • Selling the business to employees – This is similar to selling the business to an employee ownership trust but you will not be able to stay involved in the business. The main advantage is that you will get a fair price with the main disadvantage being giving up control.
  • Selling the business to a family member – This is a good option if you have a family member who is interested in taking over the business. This may allow you to stay involved in the business if you want to but there may be some tax implications such as capital gains tax.
  • Setting up a holding company – This is an option if you want to keep control of the business but don’t want to be actively involved in it. The main advantage is that you can still have a say in how the business is run with the main downside being that you will need to pay tax on any dividends you receive from the company.

successful business

Final Thoughts

There are many employee ownership trust problems and benefits to consider when deciding if it is the right choice for your business. We hope that this guide has helped you to understand the pros and cons of employee ownership trusts and the alternatives that are available. Remember, if there is anything you are unsure about, it is always best to seek professional advice.

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