The ability to sell a business without having to pay Capital Gains Tax, combined with a desire to future-proof the independence of the business they created, is seeing a rising number of entrepreneurs hand over control to an Employee Ownership Trust (EOT).
First introduced in 2014, EOTs allow business owners to sell company shares free of Capital Gains Tax, so long as they hand over control to the employees who helped build the business.
Building up a business and eventually selling to a third party has long been the more common aim for many business owners. This can often be the best way to secure the company’s future and maximise proceeds on disposal. However, the downside can be that the business loses its independence, some or all of its workforce and the unique culture that made it a success in the first place.
For business owners who don’t want to go down this path, and do not have family members to pass the business on to, EOTs are worth investigating as an alternative exit route.
How it works
Under EOT rules, owners sell a controlling number of shares in a business to an EOT at an agreed valuation. Typically, the trust will pay for those shares either through contributions from the company's trading profits and/or bank loans secured on the company’s assets.
For the owner, the sale is free of Capital Gains Tax. However, as with all share transfers over a certain value, stamp duty is payable on the transfer of shares. This is especially attractive to owners who don’t qualify for Entrepreneurs’ Relief and who might otherwise expect to pay 20% Capital Gains Tax on the sale of the business.
Providing a controlling share is sold to the EOT, not all shareholders have to sell their shares and owner/directors can remain in situ post-sale, continuing to receive market-competitive remuneration packages.
However, a key feature of EOTs for owners to consider is that the sale price is not generally all paid upfront, instead some part of it being repaid through the company’s trading profits in the years that follow.
Preparing for the future
One company to choose the EOT path is home entertainment retailer Richer Sounds, which has a chain of 50+ stores in the UK. Founder Julian Richer plans to stay involved with the business, but leave the day-to-day running to its existing management board, along with a Colleagues’ Advisory Council and trustees.
Tax efficient but get advice
Louise Jeffreys, MD of Gunner & Co, who works with businesses around the country, specifically looking at company structure and plans around exit, says: “Employee Ownership Trusts can be a tax-efficient method of extracting value, particularly if Entrepreneurs’ Relief can't be achieved.
“That said, EOTs can be challenging to implement, so professional advice is essential.” She continues: “Do you have the right people in the business to take it on and grow it (or at least maintain profitability to ensure you get paid out eventually)? Often employees are not always the best business owners/leaders. Cash flow/working capital needs to be well managed to ensure the business continues to flourish while also paying off the previous owner."
Setting up an EOT could be an option for a wide variety of different types of organisations, as a spokesperson for BDO confirms: "BDO has worked with numerous companies, as well as LLPs and groups, on establishing EOTs. They have ranged from companies with just 20 employees to over 1,800, with values from £1m to over £80m and from all sectors."
The levels and bases of taxation, and reliefs from taxation, can change at any time. Tax reliefs are dependent on individual circumstances.
Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.