The advantages (and pitfalls) of selling to an Employee Ownership Trust

The current climate may not seem particularly friendly to business owners seeking an exit, but there are options which offer considerable advantages, while avoiding some of the more difficult elements of a business sale.

One of the most popular among such options is a sale to an Employee Ownership Trust (EOT). An EOT is an indirect form of employee ownership, through which a trust holds the controlling stake in a company on behalf of employees. It also provides several incentives for owners to sell their controlling stake.

As the recent sale of the prestigious Simon Morray-Jones Architects to an EOT illustrates, this is a sale framework that is gaining popularity among businesses for numerous reasons. Here are some of the key advantages of selling to an EOT.

Tax breaks

Often seen as the crucial benefit of an EOT-sale for the selling party, it allows you to sell some or all of your shares to the trust while benefitting from some major tax exemptions. Primarily, as the seller you will have complete capital gains tax exemption on gains made when your controlling stake in the company is sold to the EOT.

Furthermore, there are likely to be no income or inheritance tax liabilities arising from the disposal of your controlling interest. There is also an income tax exemption of £3,600 per tax year on certain bonuses issues to employees. While national insurance contributions are not exempt, this will still provide additional remuneration for employees.

“Friendlier” purchase

While the aforementioned tax exemptions are generally seen as the major incentive to sell to an EOT, this is not the sole advantage. As Castle Corporate Finance director Victoria Ansell, who worked on the Simon Morray-Jones sale, points out: "We are seeing many business owners look at the option of an EOT, some of whom look at 0 per cent tax as being the main driver, but it really doesn’t work that way.”

"Simon and Berni (the previous owners of the firm) embraced this framework as being the right thing for their team, as well as for them, and that gives me a lot of confidence that the business will go from strength to strength."

Clearly, a key upside for many will be the ability to pass the reigns on to a trusted team within the company, rather than, for example, selling to a rival firm. In addition, the framework would enable you to stay on for a period to ensure a smooth transition.

No succession issues

The structure of an EOT-sale can help to easily avoid the difficulties that can plague going to market with a traditional sale. For one, the EOT allows employees to purchase a controlling stake without the use of their own funds (as the company profits will contribute to the EOT, which will be used over time to repay the outstanding price to previous shareholders), allowing a purchase to proceed almost immediately.

Furthermore, in a sale to an EOT, an independent figure will typically assess the company to calculate a valuation. This can help to ensure that you receive full market value for your shares, without the long-winded back and forth haggling between yourself and a potential buyer.

While there are clear benefits to an EOT sale, it is also true that there are numerous potential pitfalls to the process which you will need to be careful to avoid.

A realistic valuation

As the deal will be funded by future profits at the company, you are only likely to achieve a realistic valuation for the company. If you are seeking a sale at a higher price, then it may be advisable to head in a different direction.

Prepare for any eventuality

The risks of being remunerated through predicted future profits are twofold. Firstly, if the company runs into difficulty once you’ve made your exit, then this may impact the EOT and your payment. Or, if the company’s profits see an upturn in future, then the agreed-upon price may mean that you miss out on reaping the profit that your hard work contributed towards.

In either eventuality, including an anti-embarrassment clause in the contract can help to ensure that you don’t get stung.

Stick to the rules

Tax exemption can make an employee ownership sale very cost-effective. However, there are a number of “disqualifying events” which, if they occur in the tax year following the sale, can leave you liable for a hefty capital gains tax bill.

These events include: the company ceasing trading; the EOT no longer meeting employee benefit or controlling interest requirements; limited participation requirements being breached; trustees not observing the rule of equality.

Such events are reasons to consider an EOT sale very carefully. For one, if your company is in any kind of difficulty and could be at any risk of insolvency, then the tax breaks seemingly offered by such a sale may be incredible risky. Secondly, the stringent rules surrounding the conduct of the EOT mean that you will need to rigorous in ensuring that those involved are trustworthy and that the correct structure is in place for all requirements to be met.