Employee Ownership Trusts (“EOT”) 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, is growing in popularity and results in the majority of a company’s shares being owned by the EOT which holds them for the benefit of the employees.
Whilst professional services firms have historically relied on partnership structures, in recent years there has been a move to alternative ownership structures. These have evolved as a result of the next generation being unable or unwilling to invest in a partnership. An EOT can be one such structure that can allow the existing partner group an exit route, whilst also securing the future ownership and success of the firm.
Advantages and disadvantages to setting up an EOT for your law firm
This type of ownership structure can offer both advantages and disadvantages, and we will work with you to ensure that these are understood and that the structure will suit the firm’s future aspirations.
What are the advantages of an Employee Ownership Trust structure for a law firm?
- It allows an alternative exit route for situations where there is no obvious third-party purchaser or succession plan. Some equity partners, particularly those approaching retirement or wishing to take on another challenge, may want to pass on the ownership of the firm to their employees.
- The equity partners can benefit from a tax free sale of their share in the firm to the EOT if the transaction is structured correctly.
- From an employee point of view, where a firm 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 business. 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 Employee Ownership Trust structure for law firms?
- Equity partners 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 firm or through utilising existing bank facilities and/or by taking out new bank borrowings – either in the name of the firm, or more likely the EOT with a guarantee provided by the firm or, in some instances, the former equity partner(s). Any remaining consideration would be paid to the partners on a deferred basis over a number of years with funding being provided by the firm. There are clearly risks involved in selling a business to an EOT.
- It is 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 firm, which is affordable for the EOT, and indirectly the firm. Servicing too high a price can potentially put too much strain on the working capital of the business. A lack of working capital to reward employees because of the high loan repayments can work as a disincentive.
- The law firm will need to incorporate into a limited company prior to the sale to an EOT.
- Whenever a law firm’s structure or ownership changes, there is a need for it to apply to the SRA to become an Alternative Business Structure. Whilst the SRA are familiar with EOT ownership structures, this can add time and costs to the switch in ownership.
- Whilst an EOT ownership structure can solve the dilemma of how the existing partners exit from the firm, it can prevent future employees who aspire to equity ownership from achieving their aim.
How can we support your law firm to set up an Employee Ownership Trust?
If you would believe this structure would work for your law firm we can offer a free initial consultation.
If it is concluded that employee ownership is a suitable structure, we can assist the owners and the firm with the transition process, including:
- Tax advice to ensure that the EOT structure meets the conditions laid out in the legislation
- Incorporation as a limited company
- Independent valuation of the firm
- ABS application
- Cash flow modelling to confirm affordability of upfront cash payments and deferred consideration
- Management of the entire process
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