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Employee Ownership Trusts – a viable ownership structure for recruitment companies?

Posted on 24 February 2022

As companies have weaved their way through the COVID-19 pandemic, we have started to see a cultural shift in the mindset of many business leaders and owners around how employees can, and should, play a more significant part in influencing the successful growth of businesses.

In light of this, the use of employee ownership trusts (EOTs) has increased significantly in the last 18 months with 250 new employee owned businesses created in that time.

Perhaps fuelled by some high profile examples, such as Richer Sounds, Riverford Organic Farmers and John Lewis Partnership (which has long been lauded as the prime example of an employee-owned business), recruitment companies have shown an increasing level of interest in the EOT model.

Earlier this month, SSQ became an employee-owned business, now owned by an EOT giving their employees 100% ownership of the company. The motivation was to pass the business onto those most key to its ongoing success in a way that best preserved their culture. Research has indeed shown that keeping the business "in the family" can help strengthen the future success of a company, generating higher productivity, lower workforce turnover, a greater level of innovation, better recruits and more resilience to economic change.

What is an EOT?

An EOT is a special form of employee trust introduced by the Government in 2014 and with the objective of encouraging wider employee ownership, offers some very generous certain tax benefits.

If certain legislative requirements are met, existing shareholders can sell their shares to the EOT without incurring any capital gains tax – a very valuable tax break particularly given the potential for CGT rates to be increased and the limit of Business Asset Disposal Relief on a total lifetime gain of £1 million. In addition, once set up a company can pay annual bonuses to employees free of income tax of up to £3,600 per tax year.

As the majority owner of the business, it is important to carefully consider the composition of the board of trustees and the overall governance structure. The trustees would typically comprise directors of the company together with an employee representative and an independent director (such as a professional adviser). A trust deed would set out what the trust can (or cannot) do with the shares and how distributions will be made.

Once set up, an EOT must own more than 50% of the company's shares and any distributions made from the EOT must be made to employees broadly on the same terms and conditions. To enable future incentivisation, many EOT companies will also establish traditional employee share plans to run alongside the EOT structure, such as share option and share purchase arrangements.

Is an EOT a viable alternative to a trade sale?

Yes, in the right circumstances. To date an EOT has commonly been used as part of succession planning by the founding shareholders. With an emotional attachment to the business they have created, founders may want to explore an alternative to selling to a trade or private equity-backed buyer.

How an EOT is funded to acquire the business must be carefully thought through and structured (which could be through external lending or from trading profits it receives) and it quite often requires the selling shareholders to be paid out over an extended period of time. This of course might align with the aim of the selling shareholders who want to retain some influence through a transitional period, ensuring there is a smooth transition to the employees.

A sale to an EOT also has the advantages of there being an immediate purchaser, with a sale at full market value and which can be completed more quickly and with lower fees.

When considering an EOT structure, shareholders will need to take a long-term strategic review of the business and the benefits that it could bring by giving employees greater ownership and responsibility. EOTs are being adopted across multiple sectors but there is particular interest for those businesses where their people are their greatest asset.

To discuss EOTs in further detail or any aspect of employee share incentive arrangements, please contact Stephen Diosi at stephen.diosi@mishcon.com or on 0203 321 7534.

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