If you’re looking to pass on ownership of your company you might want to consider setting up an Employee Ownership Trust (EOT).
EOTs were introduced by the Government in 2014 and allow business owners to sell their shares to an employee-owned trust free from Capital Gains Tax (CGT). This form of business ownership, which is similar to the structure of the John Lewis Partnership and growing in popularity, results in the majority of the company’s shares being owned by the trust and gives employees a controlling interest.
What are the advantages of an EOT?
It allows an alternative exit route for situations where there is no obvious third-party purchaser. Many company owners, particularly those approaching retirement or wishing to take on another challenge, want to pass on ownership to their employees.
The owner can retain some involvement (up to 49%). One advantage from their perspective is that the disposal of shares to an EOT is free of CGT for UK individuals if the transaction is structured correctly.
From an employee point of view, where a company is controlled by an EOT there is a tax relief which allows it to pay annual bonuses of up to £3,600 per person income tax-free (but still subject to NI).
Many say there is a mental change when employees are involved in the ownership of a company. There is a shift that helps to drive success. Employees are more heavily involved, and it is shown to reduce absenteeism too.
What are the disadvantages of an EOT?
Owners will not always receive all the money for the sale immediately. Often they will receive a portion upfront, this amount being funded by existing cash reserves in the company or through utilising existing bank facilities and/or by taking out new bank borrowings – either in the name of the company, or more likely the EOT with a guarantee provided by the company or, in some instances, the former company owner. Any remaining consideration would be paid to the owners on a deferred basis over a number of years with funding being provided by the company. There are clearly risks involved in selling shares to an EOT.
It’s not always easy to determine the value of the business. It is important that the owners and the trustees of the EOT agree on a fair market value for the company, which is affordable for the EOT, and indirectly the company. Servicing too high a price can potentially put too much strain on the working capital of the company. A lack of working capital to reward employees because of the high loan repayments can work as a disincentive.
How is the current economic climate affecting EOTs?
In this period of high inflation what concerns businesses most are:
High energy prices
Inflation of goods and services prices
Falling consumer demand for those goods and services
Rising costs or growth targets not being met, caused by inflation and reduced market demand can impact the cashflow generated by the company from its day-to-day operations, which may fall below the level required to meet the obligations of the EOT to repay the debt to both the lender and business owner.
For EOTs, and by association the company, where loans are taken to pay for the owner’s shares plus an interest that may be charged on deferred consideration, the biggest threat can be the increase in interest rates. This has put huge pressure on these companies. A lack of cash flow hinders investment and ultimately can lead to insolvency.
What actions should EOTs take?
It is critical to prepare a rolling 13-week cash flow forecast for the company. This will identify pinch points and allow management to take appropriate action to address cash shortages.
Contact a specialist in refinancing and consolidating debt. They will ensure that the company’s cost of borrowing is reduced as much as possible by utilising all assets that can be offered as security.
If all else fails, an insolvency practitioner may be required to advise on procedures needed to ensure the survival of all or part of the business, for the benefit of creditors, employees and other interested parties.
EOTs can be an effective vehicle for owners wanting to pass on business ownership to their employees. Planning is very important, particularly stress testing to ensure that the cost of borrowing to finance the purchase of the owner’s shares is covered, even if trading is squeezed and interest rates increase.
Unfortunately, business owners who have sold their business to an EOT are experiencing challenges caused by factors out of their control. Some are now worried about the repayment of their deferred consideration by the EOT, together with the impact that any personal guarantees they may have provided to third-party lenders might have on their personal position. They now need advice on how to protect their personal assets.
For more information about Employee Ownership Trusts (EOTs) or if you are looking at your option for succession planning please get in touch.
