Employee ownership trust FAQs

An EOT is a special form of trust that owns the company shares for the benefit of all eligible company employees. Company owners can sell their shares to an EOT as an alternative to selling to a traditional buyer, benefitting from 50% Capital Gains tax relief if all conditions are met. 

The EOT must own a majority of the company shares. The sellers may still own some shares or employees may own some shares directly alongside the EOT.

The EOT pays for the shares using funds gifted to it by the company and sometimes through third-party borrowing.  A proportion of the sale price will be paid to the sellers on completion using available cash in the company and any debt raised, with the balance of the market value sale price paid by the company over time from profits.

The company is run by its board of directors as before, and the EOT is run by a separate board of directors.

The company can pay eligible employees annual bonuses tax-free up to £3,600. Any future income or gains made by the EOT from dividends or gains on a future sale of the company must be applied for the eligible company employees.

Selling to an EOT can attract substantial (50%) Capital Gains Tax relief for sellers, if all conditions are met. A sale to an EOT is also simpler and less adversarial than a sale to a traditional buyer, as there is no third party involved. There is no risk of “tyre-kickers”, losing confidential information to competitors, price chipping or extensive due diligence reviews. The sale price can be the full market value. 

Sellers can retain some shares and can remain involved in the business if they wish. Sellers can be comfortable that their employees will be protected in their current jobs and the company can continue to run as normal.

Employees benefit from annual tax-free bonuses and any future income or gains in the EOT itself. However, they do not need to invest any money, do not directly own the shares and do not have to be involved in any decision-making. The EOT trustees have to make decisions in the interests of the employees going forward. Employees can also feel that their jobs are more secure, as business will carry on as usual after the sale to the EOT. EOTs have been shown to result in increased productivity and employee engagement.

However, in many cases, the sellers will have to wait longer to receive their total sale proceeds than they would in a traditional sale. This is because the immediate cash is limited to spare cash in the company and any new bank debt raised for the purpose of selling to an EOT. The additional proceeds will be paid over time from company profits.

If the sellers do not intend to remain as active management, the company will need to have in place an alternative management team, whereas a traditional buyer may have their own management team ready to take over.

The EOT trustees will have to approve the sale as being in the best interests of the employees. The EOT repays any amounts still due to the original shareholders and any bank debt and pays capital gains tax on the proceeds (unless it is non-UK tax resident). The EOT will have inherited the original shareholders' base cost, so this gain may be significant. The EOT trustees will then decide how to share the remaining proceeds between the eligible company employees, according to strict fairness rules set out in the EOT Trust Deed. The employees will be taxed on their payments under PAYE at their normal income tax rates. The employing company will have an employer’s NIC cost in addition.

The EOT Trust itself can be set up quickly by a lawyer. The entire process of selling a company to an EOT will take at least 2 months but can take longer, particularly if bank debt is raised to allow a higher immediate cash payment to the sellers. The sellers need to take detailed tax, legal and financial advice to ensure that the tax and legal conditions are met to achieve, and retain, tax-free treatment, and that the company can afford the seller payments over a reasonable period.

There are many qualifying conditions to meet.  The main tests initially are that:

• The EOT must acquire a majority of a trading company’s shares.
• The number of company employees who are significant shareholders, or their connected people, compared to overall employees, cannot exceed 40% before and after the sale to the EOT. 

There are also a number of rules that the EOT has to follow going forward, in addition to the above tests, the main one is that the trust operates in a manner that ensures that all employees benefit fairly from the EOT according to strict criteria and that the selling shareholders (and their connected people) cannot benefit from the EOT.

• The EOT trustees must apply all income and gains for eligible company employees. If company shares are sold in future, all funds, after settling EOT debts and tax bills, must benefit the eligible employees. This could represent a life-changing amount of money for the employees.  
• After the company has paid the sale proceeds to the previous shareholders and repaid related bank debt, surplus profits that previously went to the business owners are now available to be shared among the employees.
• Companies owned by EOTs can also pay annual bonuses that are tax-free up to £3,600.

A sale to an EOT is an attractive alternative to a traditional company sale, particularly where a suitable buyer cannot be identified, or the seller is keen to preserve their legacy and protect the interests of their employees going forward. A sale to an EOT is also simpler and less adversarial than a sale to a traditional buyer, as there is no third-party involved. There is no risk of “tyre-kickers”, losing confidential information to competitors, price chipping or extensive due diligence reviews. The sale price can be the full market value. Sellers can retain some shares and can remain involved in the business if they wish. Sellers can be comfortable that their employees will be protected in their current jobs and the company can continue to run as normal.

When considering a sale, business owners should seek professional advice to help them to assess all of the options best suited to their circumstances.