The employee ownership sector is growing rapidly at a rate of 30% a year and is strongly outperforming the UK’s national productivity trend. Recent research found employee-owned businesses are 8-12% more productive per employee than their non-employee-owned counterparts.
The sector has been super-charged in recent years by the introduction of the employee ownership trust (EOT) model. An employee ownership trust (EOT) provides a structure for the sale of a trading business to a trust for the benefit of employees and enables owners to sell their shares free from capital gains tax (CGT).
In this article, we look at 5 reasons behind the growing numbers of businesses selling into employee ownership and why now is a good time to sell your business to an EOT.
Baby boomer succession planning
We are currently seeing what is being described as the largest wealth transfer in history as baby boomers hand over the reins to their businesses.
In many of the businesses we work with, there is no family successor which leaves a succession gap. Many of these business owners have strong links with their employees and communities. The EOT is attractive to these business owners as the model is proven to contribute to local communities both in terms of creating and protecting jobs and putting more cash into the hands of employees than non-employee-owned businesses.
The model is also an attractive succession option to business owners as it provides a path for a gradual succession both in terms of leading and managing the business and giving up the equity.
Owners are not required to sell 100% of their business into an EOT. There is a minimum requirement of a 51% sale of the share capital into the EOT which provides flexibility and allows owners to retain an equity interest in the company. Owners can also remain involved in the business post-sale which can be particularly important where the management team are not quite ready to step into the shoes of the founders. This also enables the founders to transfer their skills and experience to continuing management post-transaction.
Zero rate of CGT for qualifying sales
The current main rate of CGT is 20% for business owners selling their companies. Owners may benefit from a 10% rate where business asset disposal relief applies, and this is capped at £1 million of gains.
The top tax rate on dividends is currently 39.35% where returns to business owners are taxed as dividend income.
In contrast, a qualifying sale to an EOT enables an owner to realise capital gains at 0% on an uncapped basis. This makes an EOT a highly tax-efficient route for sellers selling their companies where the structure meets the sellers’ objectives.
Sharing more value created with employees
EOTs can share more of the value they create in a tax-efficient manner with their employees. EOT companies can reward their employees by the payment of cash bonuses of up to £3,600 per year free of income tax.
In addition, tax-advantaged share schemes such as Enterprise Management Incentive schemes can be operated alongside the EOT to provide additional equity incentives to key managers. This can also be a useful tool for business owners who sold their equity to the EOT in return for vendor finance which is being funded by profits in the business and who therefore wish to incentivise management to deliver profits to pay this down.
Execution certainty of an EOT transaction
Execution certainty is a significant benefit for owners, particularly where past sale processes have fallen over. An EOT effectively creates an exit event for the current shareholders without the need for an external third party. This means that once the business owners decide to proceed, the transaction can progress with less risk of “pens down” and a significantly reduced requirement for due diligence, enabling employees and managers to continue with their day jobs.
Resilience of employee-owned businesses
Employee-owned businesses are more financially resilient than non-employee-owned businesses. Research has shown that employee-owned businesses were less likely to see their profits decline over the last five years than non-employee-owned businesses (14% versus 25%) including through the pandemic and supply chain crises. For business owners whose businesses are their legacy, financial resilience and the protection of that legacy is a strong motivator to sell into employee ownership.