The game-changing rise of employee ownership trusts

In recent years, employee ownership trusts (EOTs) have gained significant traction as a dynamic and sustainable business model. In the UK, this surge in popularity is no accident; it reflects both a dedicated government strategy and growing recognition of the manifold benefits that EOTs bring to both businesses and their employees. It’s becoming ever more apparent how transitioning to an EOT can be a savvy strategic move for companies looking to secure their legacy, enhance employee engagement and reap substantial tax advantages.

What is an employee ownership trust?

An EOT is a model whereby a company is sold to a trust to be held on behalf of a company’s employees. The vendors receive a loan note for repayment of the agreed value, but importantly, this isn’t secured against the company, further bolstering the business and sharing the risk with the vendors.

Unlike traditional share ownership plans, which involve individual shareholdings, an EOT holds the shares for all employees collectively. It also offers flexibility in defining which employees benefit. Initial criteria for inclusion is a seller-determined length of service, but when it comes to making payments there are strict equality requirements. These stipulate that allocations can only be decided by three factors: length of service, contracted hours, or salary. This allows an EOT to be tailored to a company’s strategic goals, ensuring that the right employees are incentivised and that the benefits of ownership are broadly felt across the workforce.

The growing popularity of EOTs

The rise of EOTs in the UK can be attributed to several key factors:

Legislative support: The introduction of the UK’s Finance Act 2014 provided generous tax incentives to encourage adoption, specifically, a 0 per cent capital gains tax (CGT) rate for business owners who sell a controlling interest (ie more than 50 per cent) to an EOT. This is a powerful motivator for business owners considering strategic succession plans.

Economic resilience: Employee-owned businesses have demonstrated remarkable resilience, particularly during economic downturns. The John Lewis Partnership retail firm is one of the UK’s most well-known employee-owned companies and exemplifies how this model can lead to sustained success and stability. It can mitigate the impacts of economic volatility by aligning the interests of employees and the business, fostering a shared commitment to long-term success.

Enhanced employee engagement and productivity: Studies have shown that EOTs often experience higher employee engagement and productivity. When employees have a stake in the company’s success, they’re more likely to be motivated, committed and innovative. This is particularly beneficial in sectors such as manufacturing, hospitality and other services, where employee engagement directly impacts customer satisfaction and operational efficiency.

Prominent brand advocacy: The huge success of the John Lewis Partnership is the obvious example but the adoption of EOTs by other prominent brands such as Riverford Organic Farmers and Aardman Animation Studio have further reassured the market that EOTs are a legitimate and often highly beneficial option.

Why more businesses should consider the EOT model

Succession planning and business continuity: For many business owners, finding a suitable succession plan is a daunting task. Selling to an EOT offers a way to ensure the business remains independent and continues to operate according to its founding principles, protecting its legacy.

Tax advantages: The current capital gains tax relief associated with selling to an EOT is a significant financial incentive in the UK. Business owners can avoid the hefty CGT charges that typically accompany the sale of a business, making the transition beneficial for the employees but also financially advantageous for the owners.

Attracting and retaining talent: In today’s competitive job market, attracting and retaining top talent is crucial, giving EOTs the chance to differentiate themselves as employers of choice. The sense of ownership and profit-sharing potential can be powerful motivators for prospective employees, leading to a more dedicated and stable workforce.

Improved financial performance: Evidence suggests that employee-owned businesses tend to perform better financially over the long term. The combination of motivated employees, improved retention and a shared commitment to the company’s success can lead to increased profitability and sustainable growth.

Practical steps for transitioning to an EOT

Transitioning to an EOT involves several key steps that should be carefully planned and executed, as detailed below.

Valuation and financing: The first step is to conduct a thorough valuation of the business to determine the price at which shares will be sold to the EOT. Financing this transaction can involve a combination of internal funds, bank loans and seller financing.

Legal, tax and structural setup: EOTs require careful structuring from both a legal and tax perspective, so it’s beneficial to work with advisors who specialise in employee ownership to navigate this process smoothly.

Employee communication and engagement: Effective communication with employees is essential to ensure a smooth transition. Employees should be fully informed about how their EOT will work, what it means for them and how they can contribute to the success of the business under this new structure.

Ongoing governance: Once the EOT is established, it’s important to implement robust governance structures, including setting up an employee council or board to represent employee interests and ensure transparent decision-making.

The rise of EOTs represents a significant shift in the UK business landscape and offers numerous lessons for other locations. For business owners considering succession or looking to enhance employee engagement, an EOT model could provide a compelling solution. With substantial tax benefits, improved financial performance and a more motivated workforce, transitioning to an EOT can be a strategic move that ensures long-term success and sustainability.