Benefits and Disadvantages of Worker Possession Trusts (EOTs)
Employee Ownership Trusts (EOTs) are relatively new to the business world.
The 2019 EOT survey shows that there are 241 verified EOT companies and a further 34 EOT companies that have been established for a longer period and are also known as “EOTs”. Between the two, EOTs employ 23,000 people in the UK.
It is a popular model in manufacturing and professional services. A large part is represented in London and Scotland, practically none in Northern Ireland.
The entire company owns over half (55 percent) of EOTs. Another 40 percent are hybrid models, in which EOT is majority owner in addition to the shareholders and / or founders of the employees.
BDO predicts that a combination of Covid-19 and a capital gains tax (CGT) increase will result in shareholders increasingly selling companies before the end of the 2020/21 tax year.
We explain to you what an employee participation trust is and the advantages and disadvantages of the transition to this model.
What is an employee participation?
An Employee Ownership Trust is a special form of Employee Benefit Trust that was introduced by the government in 2014.
With an employee share fund, shareholders are encouraged to sell their shares into a trust held on behalf of a company’s employees. It is more common in corporate succession strategies, but can also be used when a company wants to grow or change its structure.
John Lewis was a leader in employee ownership in the UK, now with over £ 11.7 billion and a workforce of over 80,000 “partners”. Well-known companies that have acquired an employee ownership plan include Aardman, Rich Sounds, and Riverfords.
What conditions do I need to know in order to switch to this model?
To open an employee participation plan, you must meet the following criteria:
- The company whose shares are being transferred must be a trading company or the main company of a trading group
- All employees must benefit from the EOT. However, this excludes all employees of the company who already hold five percent or more of the company’s share capital at the time the trust is set up and cannot benefit from the system.
- The trustees must retain a minimum of 51 percent of the majority stake in the company on an ongoing basis.
The tax breaks are subject to these conditions, in particular 51 percent control.
In fact, many of these are ongoing conditions; Disqualification conditions can be:
- The company stops trading
- The EOT does not meet all of the employee benefit or control requirements
- A violation of the restricted participation requirement
- The trustees do not adhere to the rule of equality
Benefits of employee participation trusts
There are many benefits to the business owners, shareholders and employees.
When they are more involved in the business, employees become more motivated and innovative
“There’s a mental change that happens when you own something,” said Deb Oxley, CEO of the Employee Ownership Association. “It leads to behaviors more related to what needs to be done than what you want to do. It is this shift that helps drive success in an employee-owned company. “
Since the employees are more involved, it is shown that absenteeism is also reduced.
Tax-free bonuses for employees
Companies that are jointly owned by EOTs can also pay their employees tax-free cash bonuses of up to £ 3,600 per employee per year.
Higher employee loyalty – and employee acquisition
When employees invest more personally in the business, they stay longer. In addition, it is an attractive advantage to rely on your job advertisements to attract employees.
Co-ownership companies can be more successful, profitable and sustainable
As they play a bigger role in the business, employees become more entrepreneurial and want to contribute to the company’s success. It’s also a way to reward employees who have stayed loyal to the company and contributed to its success.
The business owner can continue to be on the board if they have not sold all of their shares and are passing on the culture and values of the business before completely leaving. “This makes the employees the stewards of the business for future generations who will make longer-term decisions and invest, which means that jobs and growth will be ingrained in the site for longer-term,” said Oxley.
This is compared to a commercial sale where there is no guarantee that the company will be able to maintain its culture, ethos, location and people.
“It gives founders the opportunity to leave the company while maintaining the company’s culture, ethos and values. At the same time, it rewards those who made the company a success and allows it to continue its part down the supply chains and serve the communities where the company operates. It is business based, ”she added.
Shareholders receive a full tax exemption on investment income
If you own a trading company, you can now sell some or all of your stock to an employee equity fund at full market value with no CGT liability.
Corporate income tax deduction for companies that offer equity incentives
There are corporate tax breaks for payments to an EOT.
Fast and smooth sale
Some shareholders want to sell to employee trusts instead of making trade sales. These sales are faster and smoother than selling through a third party buyer. This is due to fewer negotiations.
Disadvantages of employee participation
As expected, EOTs also have disadvantages. Oxley said, “It still takes hard work and dedication and is not going to protect you from market pressures.”
Let’s take a look at some of these below.
Ownership is indirect, so the company does not have full control. A trustee’s job is not to run the business, but to ensure that the business is run competently and in a manner that ensures employee engagement and engagement.
A management structure is agreed when the EOT is set up. They must have a say in the running of the company so that they can be taken into account – this can take the form of a staff council, which has staff directors on the board and a corporate constitution to define values in relation to the employees.
You need to trust the trustees to behave well
Entry into an EOT depends on your trustees following the rule of equality.
Shareholders do not receive the money for the sale immediately and therefore take a higher risk
Money from an EOT is paid out to shareholders over time, rather than instantly like a market sale.
The profits in the business may not be enough to pay off the entire sale price in a reasonable time, which could put shareholders off. Keep in mind that the value that shareholders will receive may be less than if the business were sold in the open market.
It is not always easy to determine the value of the business
It can be difficult to reconcile the value of the deal and the funds shareholders will receive from the EOT. However, don’t fall into the trap of overvaluing the company – you’re adding to the risk by increasing the price.
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Complex and potentially expensive
EOTs operate according to complex rules that can be difficult to understand. A decline in company performance could also impact funding and prolong the selling process for shareholders. The sale takes place gradually, often over several years.
The price can also be variable. “As with any transaction that requires legal and financial assistance, it will depend on the cost of the company (or companies) services that you are using. In general, moving to employee ownership will cost no more or less than a commercial sale, ”Oxley said.
Is an employee participation right right for my company?
Employment trusts have their advantages, but they are not suitable for every business.
They could work for you when you retire or are interested in another succession plan. Alternatively, you might feel that a trade sale or management buyout isn’t appropriate, or you might be a start-up with a very strong team that has a common purpose.
It could be a better reputation if you are a medium business. EOTs have been particularly successful in organizations with 50 to 250 employees, although overall EOT numbers are still low.
Whatever you want to do next, be sure to take a look at your other options before committing to an EOT. For more information, contact a lawyer or visit the Employment Ownership Association website.
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