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Considerations when creating an employee ownership trust

View profile for Aaron O'Brien
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Employee Ownership Trusts (EOTs) are an increasingly popular alternative to more traditional ways of selling shares. An EOT is where a trust is set up either by or on behalf of the employees of a business, giving them a controlling interest within the company.

An EOT can not only provide certain tax reliefs on the sale of shares, but also allows shareholders peace of mind moving forward that the sale of their shares will not have a negative impact on how the company is ran.

However, before you decide to create an EOT there are a few points that should be considered:

Controlling interest requirement

In order to take advantage of the statutory benefits of an EOT, one of the key requirements an EOT must meet is the controlling interest requirement. An EOT must have a controlling interest of over 50%. It is important to note that this goes beyond solely holding over 50% of the company shares. The EOT must also hold over 50% voting rights and be entitled to more than 50% of the profits.

This is something that must be noted if shareholders are planning on retaining some of their shares in the company alongside the creation of an EOT. The EOT will become an extremely powerful group when it comes to business decisions. This means that existing shareholders must be aware that for many business decisions they will not have the same level of control that they once had.

In order to ensure that remaining shareholders can still have a say in the running of the business, amendments may be needed to be added to their shareholder’s agreements to ensure that key business decisions must still need their approval before it can be passed.

All employee benefit requirement

The EOT must also meet the all employee benefit requirement. Here there are a number of points that you must consider when thinking if an EOT is suitable for you and your company.

Despite the name of this requirement, in practice not all employees must be included in an EOT for it to meet the legal requirements. New and temporary employees are permitted to be excluded when setting up an EOT. The requirement here is 12 months continued service. Therefore, if an employee has been working at the company for less than 12 months when the EOT is set up, they do not have to be included when setting up the trust. However, once they have worked at the company for 12 months, they will need to then be added. In addition, it is also permitted to exclude certain employees due to disciplinary proceedings. These points ensure that both the employees and shareholders feel reassured that the EOT is ran by and for the benefit of employees loyal to the business and will not act against the company’s interests.

Limited participation requirement

The next point to be considered under this requirement is the excluded participators. Any employee who has held over 5% shares in the company, in the past 10 years, will be unable to benefit from the Capital Gains Tax incentives of the EOT. This is because it is only supposed to benefit the employees and not be taken advantage of by shareholders. This includes any ‘close company’ including any subsidiaries and any company that has put into the EOT. Finally, anyone that is a ‘connect person’ to any of the above, will also not be able to benefit from the EOT.

This means that in practice, many family ran SME’s will not be able to see the full benefit of an EOT as many employees may be either family members or shareholders in the company. Therefore, a more traditional sale of shares may be the best avenue for them moving forward.

Another issue for small businesses here is that the number of shareholders with over 5% of shares cannot be 2/5 of the overall employees in the trust. Therefore, employees who aren’t currently shareholders must make up at least 60% of all employees, directors, and shareholders for the trust to be legitimate for tax purposes.

Equality requirement

The equality requirement means that all employees must be treated as the same under the trust. However, this does not mean that all employees must be paid equally. It is possible to differentiate between employees on factors such as years in service, hours worked and remuneration. What this means is that certain staff cannot then receive a bonus on top of the calculation if others do not also receive this.

Trading requirement

The final requirement is the trading requirement. This means that the company the EOT is buying shares in must be a trading company, or the holding company of a trading company to receive the full benefits permitted to EOTs.

Although this may seem an obvious point, it is not enough for a company to be getting set up to begin trading. This means that for any new companies starting up, an EOT would not be an appropriate avenue at this time. It is only once the business has begun to trade that it can then set up the EOT.

Financing of sale

Now that the requirements for an EOT have been set out, it is important to consider how the sale will be carried out. There are many ways in which this can be done, all of which bring their own challenges and should be carefully considered before going ahead with the sale to the EOT:

  • The trustee can borrow the money in order to finance the purchase of shares and set up the trust
  • The company may borrow the money themselves and then lend it to the trustee on creation of the trust
  • The company may decide to borrow the money on behalf of the trust and then make payments into the trust instead of putting the full amount directly into the trust
  • Seller sells shares on a deferred payment basis in order to allow the sale of shares to go ahead without the need to loan money from a third party

Once this has been considered the sale process remains largely the same as in any other sale of shares. However, the main difference is that employee representation will be needed in the sale process. As this is a trust ran by and for the employees, it is important that they consider who will be their representatives and how the trust will be managed. This is not something that the current shareholders should be involved in and instead should be decided between the employees prior to the sale of shares.

As shown above, there are many things that must be considered before setting up an EOT, if you would like any further advice on whether an EOT is right for you and your company. Please contact our commercial law team on 0161 696 6170 for further advice and assistance in setting up an EOT.