Employee Ownership Trusts (EOTs) are a special form of employee benefit trust that was first introduced by the UK government in 2014 to promote employee ownership and encourage more shareholders to set up corporate structures like the ‘John Lewis model’.
EOTs do not involve direct share ownership by employees. Instead, a controlling interest in company is transferred to an all-employee trust, where it is then held for the benefit of the employees. The John Lewis Partnership is the largest employee-owned business in the UK, with total trading sales of over £12.3 billion and a workforce of 80,000 partners.
EOTs give business owners the opportunity to sell some, or all, of their shares to employees via a trust company for full market value. In doing so, they do not incur income, capital gains or inheritance tax liabilities on the disposal.
As a result, EOTs are becoming increasingly popular amongst entrepreneurs looking to exit their business. There has been a 200% increase in the number of businesses transferring ownership to employees through EOTs, from 127 in 2019 to 384 in 2021.
A qualifying EOT is established with a corporate trustee company and the shareholders then sell their shares to the trustee under a share purchase agreement with the market value determined by an independent share valuation.
On the sale of the shares, the purchase price will create an outstanding debt owed by the trustee company to the shareholders. The company will continue to generate trading profits each year from which it will make contributions to the EOT. The EOT will use these contributions to repay the outstanding purchase price that it owes to the shareholders.
As all employees receive an indirect stake in the company or group, the structure should promote improved business performance through increased employee engagement, improved employee retention and better alignment of goals between stakeholders and employees.
To carry out a qualifying sale to an EOT, the trustees must restrict the application of the shares for the benefit of all eligible employees on the ‘same terms’ and must retain, on an ongoing basis, at least a 51% controlling interest in the company or group. The number of continuing shareholders who are directors or employees – or any associated persons – must not exceed 40% of the total number of employees of the company or group.
Trust property must generally be applied for the benefit of all eligible employees on the same terms, but the trustees may distinguish between employees on the basis of remuneration, length of service and hours worked. Companies controlled by EOTs can also pay tax-free cash bonuses to their employees of up to £3,600 per employee per year.
EOTs may be the answer for owners facing difficulties when planning their own exit if a trade sale is unlikely or if raising the funds for a management buyout (MBO) is not realistic. While the EOT is run by trustee, the existing management team of the company continues to run it after the transfer of the shares to the EOT.
Shareholders can also continue to work in the company after their shares are transferred to the EOT. This allows owners to transition gradually to retirement, which might not be possible if their shares were sold to a third party.