UK: Employee Ownership As A Business Succession Solution

Last Updated: 10 March 2016
Article by Graeme Nuttall and Jennifer Martin

Employee ownership has proved itself a successful UK business model for decades. The introduction of employee ownership trusts in the Finance Act 2014 has raised interest in employee ownership as a business succession solution. The following article looks at the advantages of an employee buy-out over a trade sale or MBO.

I.          What is Employee Ownership?

According to "Sharing Success, The Nuttall Review of Employee Ownership" (BIS, 2012) (the "Nuttall Review") employee ownership ("EO") is defined as: "a significant and meaningful stake in a business for all its employees. . . What is "meaningful" goes beyond financial participation. The employees' stake must underpin organisational structures that promote employee engagement in the company."

In an employee buy-out ("EBO") this means that the employees acquire at least a majority shareholding in their company and that this stake is used to perpetuate an EO ethos in the company. This broadly involves an ethos in which employees assume responsibility for maximizing their contribution to the business, receive full information on the business and where opportunities are given to employees, whether individually or through representatives, to influence the development of the business. There will typically be a board of directors of the company chosen for their skills and experience although sometimes there is an employee elected representative on the board. There is flexibility to design the management and governance arrangements in a way that works best for that particular business. The recent White Rose Centre for Employee Ownership report on Employee Ownership In Britain Today  highlights the variety of models of EO.

II.         Employee Ownership Trusts

Employee benefit trusts ("EBTs") have been used by companies to support the direct ownership of shares by employees. An EBT of this sort is typically closely controlled by a company's board of directors and has been used as a share warehouse and for buying and selling shares as part of a share or share option plan. But there is a different way of using an employee trust: as a part of the ownership and governance arrangements of a company. This approach involves the trust holding shares permanently on behalf of a company's employees.

The John Lewis Partnership is a flagship example of an employee trust owned company. There are many others, such as Arup and Swann Morton. Notwithstanding the success of these businesses, until recently there was a general lack of awareness of this way of owning a company. The Nuttall Review was an independent report to the Government in 2012 on what was needed to drive EO into the mainstream of the UK economy. Following its publication, the Government agreed to promote EO in all its forms and in particular the trust model of EO. Since 2012, the Government has shown its support by a number of regu­latory and non-regulatory measures ( click here to read about these).  One of these measures was the introduction of employee ownership trusts.

An employee ownership trust or "EOT" is a particular type of EBT introduced by the Finance Act 2014. It gives rise to two helpful tax exemptions which in outline are:

  1. a capital gains tax ("CGT") exemption, available to individuals who sell a majority shareholding in a trading company to an EOT (sections 236H to 236U of the Taxation of Chargeable Gains Act 1992); and
  2. an income tax exemption for certain bonus payments made to all employees of a company con­trolled by an EOT, of up to £3,600 for each employee per tax year (Chapter 10A, Part 4 of the Income Tax (Earnings and Pensions) Act 2003).

There are conditions which need to be met in order for an employee trust to qualify as an EOT. These are detailed and technical in nature but, in broad terms, they restrict the ability of the EOT trustee(s) to apply trust property for the benefit of only selected beneficiaries—any distributions must be made to all employees, on the "same terms'.

III.        EBOs

EO could be achieved by all employees buying shares directly in a company from the existing owners. But, in practice, EBOs often involve an employee trust as the purchaser of shares, with a corporate trustee holding those shares indefinitely on behalf of all employees. The new EOT CGT exemption was designed to encourage EBOs of this sort, and to raise awareness generally of EO. Typically someone selling a private company would expect to benefit from entrepreneurs' relief and pay CGT at 10%. The new EOT exemption means that the idea of an EBO should get considered as an alternative to a management buy-out or other form of exit. An individual or group of individuals can sell shares to an EOT and, provided all conditions are met, that sale will be free from CGT - this is an important incentive, in particular, for individuals who wish to perpetuate the independence of their business rather than, say, sell to a competitor.

IV.        Advantages of an EBO

In some respects, the purchase of shares by an EOT is the same as any other sale. There are, however, some key differences in addition to the EOT tax exemptions, which help make an EBO attractive.

An arm's length sale to a third party would typically involve the selling shareholder in the following:

  • a full due diligence exercise, involving disclosing confidential information;
  • detailed negotiations on price;
  • agreeing comprehensive long form sale documents;
  • accepting that at least part of the consideration for the sale is dependent on the future profitability of the business being sold;
  • losing their influence over how the business is operated and developed in the future;
  • a lack of control over the timing of the sale; and
  • uncertainty over the support for the business going forward from all its employees (which may impact on any "earn-out" payments).

A management buy-out can also involve much of the above and the use of a "Newco" as the buy-out vehicle.

By contrast, because there are no third parties involved, a typical EBO (using an EOT to acquire at least a controlling shareholding) would involve:

  • no detailed due diligence and no disclosure of confidential information to third parties;
  • quicker agreement on the value of the company;
  • shorter form sale documents;
  • agreed instalment payments for any consideration not paid upfront;
  • continuity regarding the existing ethos and independence of the company;
  • complete control over the timing of the EBO;
  • support from all the employees for the business following the change in ownership; and
  • no need for a "Newco".

The above is a very brief overview. There are risks with an EBO. In a sale to a third party the funding for the purchase depends on the financial strength of the buyer. An EBO is usually funded by the company itself and so the sellers are dependent on the company's continued success to finance any deferred consideration.

V.         Carrying out an EBO

There are various legal, tax, financial and practical issues to work through when implementing an EBO. A thorough analysis of these is outside of the scope of this article however, the following illustrate a couple of these issues.

A.         Financing

Is external finance needed? Typically the company itself will provide funds to the trustee of the EOT which will, in turn, use those funds to pay consideration to the selling shareholders. Careful consideration should be given to the company's current and projected cash flows in order to ensure that sufficient cash remains in the business. The consideration can be paid in instalments and, depending on the circumstances, external (e.g. bank) finance may be available on terms compatible with the EBO's aims.

B.         Employee Engagement

The new EOT controlled business needs to understand how best to maximize the potential benefits of EO. There should be as much focus on this element as on the terms of the EBO. It can be useful to become a member of the Employee Ownership Association or other sector bodies at an early stage in order to learn from the experience of existing successful employee-owned companies (click here for details).

EO is a growing part of the U.K. economy. Employee-owned companies of all sizes across a diverse range of sectors contribute over 30 billion pounds to U.K. GDP annually. The introduction of EOTs is helping to promote the concept of EO more widely and it should be considered by anyone looking at business succession solutions.

This article was first published by Bloomberg BNA in Tax Planning International, European Tax Service, International Information for International Business, Vol 18, No.2 Feb 2016.

Previously published in the BNAI European Tax Service Monthly Digest, 18 ets 2, 02/28/2016.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Fieldfisher LLP
Fieldfisher LLP
Fieldfisher LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Fieldfisher LLP
Fieldfisher LLP
Fieldfisher LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions