Is Employee Ownership an Option for your Business?
What do Riverford, the organic vegetable box company, Richer Sounds, the hi-fi chain and Turleys, the planning consultancy have in common? Well, as from May 2019, they are or are about to become employee owned businesses with Julian Richer being the latest business owner to announce he is transferring 60% of his shareholding into an Employee Ownership Trust (EOT).
It is not uncommon for shareholders to incentivise employees by giving them shares in the company, indeed, many see it as a way to retain and motivate their best staff members. However, transferring the majority shareholding of the company to the employees other than through a management buyout, was a concept that wasn’t that well used.
However, the Finance Act of 2014 gave companies the ability to do this in a tax favourable manner by using an EOT. Since then there has been a steady stream of shareholders looking at this model for a variety of reasons, be it succession planning, altruistic giving or to keep a highly skilled workforce motivated.
How Does the EOT Model Work?
An EOT is established with a corporate trustee. The corporate trustee then acquires a percentage of shares from the shareholders of the target company and holds them in the EOT for the benefit of the target company’s employees. It must be more than 50% of the ordinary shares.
The sale will usually result in the purchase price being owed by the trust company to the selling shareholders. Most companies using this model have sought an independent valuation to determine the sale price, but it is open to altruistic shareholders to transfer the shares to the trust company for a nominal value. In the case of Richer, according to the Guardian he will receive an initial £9.2million and then additional payments over a 15-year period linked to the company’s success. There are no details as to how the initial payment has been funded but this could be from existing profits retained in the company or a loan to either the company or the trust. In some transactions no payments are made upfront, instead the selling shareholder may agree to be paid in instalments over a period of time and may choose to take some security for this deferred consideration.
Once the transaction has completed, the target company continues to trade and pays profits into the EOT. The terms of the Share Purchase Agreement will dictate the repayment terms for any outstanding sale consideration. The terms of the Trust Deed will set out the details of how profits are to be shared by the employees.
The EOT model can only be used by a trading company or the holding company of a trading company. There are requirements set out in the legislation relating to a variety of matters such as all-employee benefit, controlling interest and equality which must be met. We talk about the procedural requirements in more detail here.
Using an EOT in succession planning
EOTs have provided another option for shareholders when planning their exit. There are many advantages to choosing this route, such as:
- Preserving the culture of the business – it avoids an aggressive outsider acquiring the business and changing the strategy.
- As long as a controlling interest is sold, shareholders do not have to sell their entire interest nor do all shareholders have to sell.
- There are significant tax advantages to the selling shareholder.
- The shareholder can receive full market value for the shares as there will be an independent valuation.
- The employees do not have to use their own funds to purchase the shares.
- If the shareholders are owner managers, they may continue to be employed by the business (often the employees are keen for the shareholders to remain in employment so they can access their knowledge and seek guidance). In the case of Richer Sounds, Julian Richer is staying on as a director and he is one of the four trustees of the EOT.
- It is often a friendlier sale which leads to a quicker process.
- It provides an ideal way to reward loyal, hardworking employees.
Professional services firms and EOTs
EOTs have proved popular with architects. Online news site, TheBusinessDesk.com, recently reported the sale to an EOT of Manchester based Triangle Architects and reported that 15% of the UK’s top 100 architectural practices have adopted this model.
Employee ownership could work equally well for other professional services firms, with many of them now already established as trading companies as opposed to traditional partnerships.
For practical, commercial advice on whether an EOT is a suitable option for your company, please get in touch.