What Is An Employee Ownership Trust?

Andrew Haimdas November 13, 2024

Employee Ownership Trusts (“EOTs”) are a government initiative to encourage more employee ownership and engagement within businesses. The popularity of this form of ownership is increasing and there is a clear appeal to both small and large companies. John Lewis, Howden, and Go Ape are all well-known examples of successful EOT businesses.

For business owners considering a sale, establishing an EOT may prove to be the most suitable option, particularly where there is no ready market of acquirers and employees will be the people most incentivised to take over the business.

Note that an EOT is a form of indirect employee ownership, and it bears similarities to other trusts in the sense that shares of the company are held on trust by the trustees for the benefit of the beneficiaries (the employees of the company).

Who are EOTs Suitable For?

EOTs are particularly suited to small and medium-sized businesses looking to reward and retain employees via employee ownership. EOTs are also an ideal solution for business owners who do not have a clear succession plan and wish to exit in a way that provides financial security whilst recognising their employees’ contributions. By aligning the interests of employees with the business, EOTs offer an appealing alternative to traditional exit strategies like trade sales or management buyouts.

Unlike direct employee ownership, where employees hold shares individually, EOTs involve indirect employee ownership. Under an EOT, shares are held in trust by trustees for the employees, making the trustees the official owners of the company. This setup means that trustees typically maintain control over the company post-sale, guiding its direction for the benefit of employees as beneficiaries.

EOTs are best for companies looking to engage employees as collective stakeholders without the complexities of individual share ownership.

Key Requirements for Establishing an EOT

To establish an EOT, several important requirements must be met to ensure eligibility for tax benefits and to maintain the integrity of the trust structure:

Equality Requirement: Every eligible employee must benefit from the EOT on broadly the same terms. While factors such as an employee’s salary, length of service, and hours worked may influence individual benefits, the equality requirement ensures that all employees receive some share in the financial distributions, such as qualifying bonus payments made by the company.

In the event of an employee’s passing, and if permitted by the trust deed, qualifying bonus payments may be distributed to the employee’s spouse, civil partner, or dependents within 12 months of their death.

This condition must be in effect at the time of the share transfer and maintained throughout the remainder of the tax year.

Controlling Interest Requirement: To qualify as an EOT, trustees must hold a controlling interest in the company. This includes:

owning more than 50% of the ordinary share capital;
holding a majority of the voting rights;
being entitled to more than 50% of the company’s profits;
being entitled to more than 50% of the assets if the company is wound up; and
retaining the right to consent to any reductions in these entitlements.

These conditions do not need to be met at the beginning of the tax year but must be fulfilled by the end of the tax year in which the shares are transferred.

3. Trading Requirement: For the EOT to qualify for Capital Gains Tax relief, the company must be either a standalone trading company or the main company within a trading group. Similarly, for income tax relief eligibility, the company must either be a trading company or part of a trading group.

4. Limited Participation Requirement: This requirement consists of two parts:

beneficiaries of the EOT cannot include former owners who sold 5% or more of their shares to the trust; and
the “participator fraction,” or ratio of employees to sellers, must not exceed 2:5 (or two sellers for every five employees). Dependents of the seller do not count as employees under this rule. However, tax relief remains available even if this ratio is exceeded, provided the excess does not persist for more than six months.

5. No Related Disposal Requirement: To qualify for tax relief, the individual claiming relief (and any connected persons) must not have previously claimed relief for any disposal of shares in the same company or corporate group in prior years.

Key Features of an EOT-Run Business

Trustees: While there are no strict rules on who can serve as a trustee, a balanced trustee board typically includes a mix of members to represent diverse perspectives. Commonly, the board comprises the company founder, an employee representative, and an independent trustee to ensure impartial oversight and balanced decision-making.
Letter of Wishes: To preserve the original values and vision of the business, the former owner may provide a “letter of wishes.” This informal document can outline guiding principles or practices that have contributed to the company’s success. While non-binding, the letter of wishes serves as a valuable reference for trustees to honor the founder’s intent as they guide the business forward.
Employee Council or Forum: Establishing an employee council or forum is a crucial aspect of an EOT business, fostering open communication and a sense of ownership among all employees. This body allows employees to participate in discussions about the company’s direction, voice concerns, and share ideas, enhancing engagement and collective responsibility within the EOT structure.

Benefits of an EOT

A Viable Succession Strategy for Founders: EOTs offer a generous financial solution for business owners looking to step away from active management. By transferring ownership to an EOT, founders secure a succession plan that provides continuity for the company and preserves its legacy, even when a traditional sale or successor is not readily available.
Increased Employee Engagement and Business Resilience: An EOT empowers employees by giving them an indirect stake in the business’s success, fostering a sense of shared responsibility and commitment. This ownership stake often boosts morale, enhances loyalty, and contributes to a more resilient and productive workplace culture.
Attractive Tax Benefits for Founders and Employees: EOTs provide substantial financial incentives for business owners to make the transition, including relief from capital gains tax, income tax, and inheritance tax. These tax advantages make EOTs a cost-effective choice for business owners looking to exit while benefiting their employees.
Annual Tax-Free Bonuses for Employees: To further encourage employee ownership, EOTs allow for tax-free cash bonuses of up to £3,600 per employee per year. This additional benefit rewards employees directly for their contributions to the company’s success, enhancing job satisfaction and aligning personal and company growth.

Potential Disadvantages of an EOT

Challenges in Securing Employee Buy-In: Successfully transitioning to an EOT requires strong employee engagement, which can sometimes be difficult to achieve, particularly if employees are unfamiliar with the concept of shared ownership. Clear communication and education are essential to help employees understand the benefits of the EOT structure and their role in the company’s continued success.
Deferred Payouts for Founders: Unlike traditional sales where owners may receive immediate payment, EOT transactions typically involve installment payments over several years. This extended payout period may not be ideal for owners who seek a quick financial exit.
Leadership Succession Planning: Transitioning ownership to an EOT requires thoughtful planning around leadership succession. Business owners need to ensure that capable leaders are in place to guide the company forward, maintaining stability and preserving the founder’s vision. Establishing clear leadership paths is crucial for a smooth transition and long-term success under the EOT model.

Legal Documents and Reports Required to Establish an EOT

Core Legal Documents

The following key documents are essential to establishing an Employee Ownership Trust:

Employee Ownership Trust Deed: The foundational document that outlines the terms of the EOT, including the roles of trustees, the beneficiaries (employees), and the rights associated with the shares held in trust.
Share Purchase Agreement: This document details the terms and conditions of the transfer of shares to the EOT, including pricing, payment terms, and any other stipulations regarding the acquisition.
Founder Shareholder Agreement: A critical operational agreement that defines the structure and practical controls of the company, outlining how it will be managed post-transition and ensuring alignment with the founder’s intentions.
Updated Company Articles of Association: These articles must be revised to reflect the new ownership structure and governance under the EOT, ensuring compliance with legal requirements and clarifying roles and responsibilities.
Trustee Company Articles: Specific articles governing the operations and powers of the trustee company, which holds the shares on behalf of the employee-beneficiaries.
Profit Sharing Policy: A policy that sets out how profits will be distributed among employees, ensuring transparency and fairness in line with the EOT’s goals.

Supporting Reports

In addition to the legal documents, the following reports help guide the establishment of the EOT:

Project Review Document: This document outlines the goals and objectives of transitioning to an EOT, providing clarity on the desired outcomes and strategic direction for the business.
Final Report: The final report summarises the process, providing guidance on the core legal documents and ensuring that all necessary steps have been followed for the successful implementation of the EOT.

Conclusion

It is important to consider the complexities associated with establishing an EOT and to ensure the process meets the requirements of the parties involved.

If you would like to understand more about the process of establishing an EOT, our experienced solicitors can help. For most new matters, we offer a 20-minute introductory call to find out more and discuss the issues before providing you with a relevant fee quote.

Please email wewillhelp@jonathanlea.net providing us with any relevant information so we can ensure that any call we have with you is as productive as possible.