Employee ownership trusts, commonly referred to as EOTs, enable employee ownership of a business by giving business owners the opportunity to sell their shares to a trust which is run for the benefit of employees.
The trust will essentially own a majority stake in a company which is held for the company’s eligible employees. An EOT is a specific form of employee benefit trust.
Rather than employees having direct share ownership (i.e. holding shares personally), shares are held indirectly on behalf of and for the benefit of the employees.
Employee ownership trusts have many advantages and business owners are increasingly considering this option when succession planning.
The employee ownership model can be particularly useful where a business owner wishes to retain a minority interest in the trading company or wishes to have some continued involvement in the business. It can be set up to allow for a smooth and gradual transition of ownership of the company if necessary.
Employee ownership trusts also have considerable tax breaks. In particular, provided that certain qualifying conditions are met, business owners who dispose of a controlling interest in a company to an EOT can claim a full UK capital gains tax exemption on the disposal. There are also income tax reliefs available on the sale of the shares.
Once an employee ownership structure is in place, the trading company can pay annual bonuses of up to £3,600 per eligible employee per tax year, which are exempt from income tax.
Employee owned companies can also increase staff retention as it follows the John Lewis model of the business being owned by staff. By providing employees with a stake in the company they work for, it will likely improve employee engagement and encourage increased productivity and innovation.
The trust is essentially the vehicle that enables a company to become employee-owned. The company will be the “settlor” of the trust and set up the trust via a trust deed. The trust deed is drafted usually by the lawyers acting for the company. The company, as the settlor, will appoint the initial trustee.
The trust deed will establish and regulate the employee ownership trust going forward. It will also set out who qualifies as a beneficiary (i.e. the qualifying employees of the company). In this regard, it will mirror the requirements of the relevant tax legislation to enable the company and selling shareholders to qualify for the relevant tax reliefs. The trustee will essentially operate the trust in accordance with the trust deed for the benefit of the beneficiaries.
The trustee of the trust will usually either be a corporate trust company or a professional trustee.
A corporate trust company is probably the most common choice, particularly for smaller businesses. Often the corporate trustee is a company limited by guarantee or by shares. There will be a board of directors so decisions are made by the board (rather than individual trustees). The corporate trust company will hold the assets of the trust.
With corporate trustees, the board of directors will need to be picked carefully. Whilst it is not uncommon for a director of the settlor company to also be a director of the trustee company, they need to be aware of potential conflicts of interest between their respective roles. It is generally advisable to have a balanced board of directors. Often the board will comprise of at least one individual who is also a director of the settlor company, at least one employee of the company and usually an individual who is completely independent.
Another option is to appoint a professional trustee – this is a paid firm or person who is experienced in administrating trusts. The main advantage of a professional trustee is that it will handle the administration of the trust, such as preparing trust accounts. This can be particularly useful where the trust will operate a complex employee share scheme or where there are large numbers of employees as beneficiaries. However, as trust administration is a specialised area, professional trustees can be quite costly.
As discussed above, the settlor company will firstly establish the trust via a trust deed. The selling shareholders will then transfer more than 50% of their shares in the company to the trustee to enable the trustee to have a controlling interest in the company.
The trustee will hold the shares on trust for the eligible employees in accordance with the trust deed. The formal instrument to transfer shares is a stock transfer form.
To also document the sale to an EOT, the selling shareholders and the trustee will enter into a share purchase agreement which will set out the terms of the transaction, including the purchase price of the shares. The main focus of the share purchase agreement will be on the consideration and payment mechanism, for example, dealing with any deferred consideration. There will also be some ancillary documents to the main agreement, such as board minutes, to authorise the transaction. Overall, there are several key legal documents required for the transfer of the shares to the trustee company.
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