Advantages and Disadvantages of an EOT

Advantages of an EOT for the selling shareholders

One of the main incentives for the selling shareholders to sell their shareholding in a company to an EOT is the beneficial tax treatment offered. A sale to an EOT offers 50% relief from Capital Gains Tax provided that certain requirements are adhered to which amongst others include:

• The EOT acquiring more than 50% of the issued share capital of the company;
• The benefit derived from the EOT being for all employees subject to limited exceptions and on the same terms;
• The company being a trading company; and
• The requirement is that the number of employees who own 5% of the company must not exceed two-fifths of the workforce.

In addition to the tax benefits a sale to an EOT also offers the selling shareholders some other benefits.

EOT ownership can be an attractive option for the company owners seeking to preserve a company’s independence and values, as the EOT model allows the business to continue operating as it has to date.

A sale of shares in the capital of a company to an EOT can also save time and money as it provides the selling shareholders with an opportunity to sell their shares without the need to find a third party buyer that will conduct due diligence on the company and require the selling shareholders to give a series of warranties and indemnities relating to various aspects of the company and its business which may not be required on sale to an EOT.

The selling shareholders will also be able to lead upon the sale to the EOT and therefore can control the timescales for implementing the transition to EOT ownership.

Advantages of an EOT for the employees

The EOT ownership model is an indirect employee ownership model whereby the shares in the capital of the company are held on trust for the benefit of the company’s employees, therefore the future profits and growth of the business will be for the benefit of the workforce as a whole.

A key benefit for employees is their ability to receive, subject to certain conditions, an annual bonus of up to £3,600, which will be income tax-free (although subject to national insurance contributions).

Whilst the employees will not be able to directly control the direction of the company under the EOT ownership model, companies with a larger number of employees can set up an employee council, whose role will be to listen to the concerns of employees and feed those views back to the trustees which may ultimately influence how the company operates.

Advantages for the company itself

For the company, the EOT ownership can help improve productivity of employees and, in turn, the financial performance of the company, as employees of the company feel incentivised as they have an indirect stake in the business.

EOT ownership model can also assist with the recruitment and retention of employees as it can act as a key differentiating factor of the company within the market in which it operates.

Disadvantages of an EOT for the selling shareholders

As the available tax reliefs have strict qualifying conditions attached to them, there is a risk that the tax reliefs could be lost if a disqualifying event occurs before the end of the fourth tax year following the end of the tax year of disposal, this was until the Autumn Budget the end of the following tax year after the disposal of shares.

To mitigate this risk, the trust or the company will usually undertake not to take steps that would result in the occurrence of a disqualifying event and possibly even indemnify the selling shareholders against the loss of any tax reliefs.

It is common for the acquisition of shares by an EOT to be funded out of future profits of the company and it therefore may be a number of years before the selling shareholders receive the entirety of the proceeds of the sale.

There are, however, debt finance and future refinance opportunities available, which may help with this and reduce the timescales for payment of the purchase price.

The principal disadvantage for any selling shareholders who are not seeking a full exit upon sale to the EOT is the loss of control over the company. The selling shareholders should, therefore, be comfortable with this transition of power. 

A shareholders’ agreement can help, however, provided that it does not indirectly preserve control with the selling shareholders. 

Disadvantages of an EOT for the employees

There are a few disadvantages for the employees, although employees who foresee themselves as future business owners may feel that there is less scope for this under the EOT ownership structure.

However, it is still possible to award employees with direct share ownership or offer share options under the EOT ownership structure, provided that doing so does not result in those persons having a controlling stake.