UK: An Easier Way To Pass The Baton

Last Updated: 22 August 2016
Article by Graeme Nuttall and Jennifer Martin

Employee ownership avoids the difficulties of a management buyout or other traditional exits for owner-managers. This business model recently delivered the successful transition of a real estate agency into new ownership and management, benefiting the founders, employees and clients.

An alternative to a trade sale or management buyout

Owner-managers have to plan for their eventual withdrawal from their business. In a family business there may be a next generation to take over. Otherwise the usual choice of exit, depending on the type and scale of business, is between a trade sale or a management buyout ("MBO").

RPC Land & New Homes Ltd ("RPC") is a business that enjoyed more than 17 years of independence, specialising in the sale of land and new homes throughout Kent, south-east London and Sussex, and so a trade sale was quickly ruled out. But why did its shareholders, Peter Randall and Mark Linington, prefer an employee buyout ("EBO") over an MBO? Business owners are increasingly turning to employee ownership ("EO") as an alternative to an MBO. EO offers management and ownership succession without the need for a group of managers to take on the financial risk of buying out existing shareholders. Some managers are happy to accept this risk, but it becomes divisive if only some do.

Managers need to recognise the fundamental uncertainty as to what happens when they wish to sell. Can they be sure that when they want to retire or step back that a trade sale or another MBO will be possible at that time, and at the right price? Some simply reject an MBO because they are asking managers to "buy" promotion. Why should promotion be based on ability to pay or a willingness to invest? Questions like these prompted a rethink at RPC. A planned MBO metamorphosed into an EBO. In many businesses, such as professional partnerships, the owners do not have an equity stake in the business, so when they leave there is no need to value their stake and buy them out. EO, using an employee trust, can achieve a similar effect in a private company. This was the route taken by RPC. An employee ownership trust ("EOT") bought out the founders and locked-up all the equity of the business in a trust in perpetuity (or at least for as long as the law allows). This method allows managers to focus on running a business rather than worrying about who will buy them out when they wish to retire.

Trusting in employee trusts

EO is a tried and tested way of owning and managing a business. Research supports EO as providing a win-win business model that is good for the business itself and for its employees (see Nuttall Review of Employee Ownership (BIS, 2012)). There are numerous examples of the success of employee-owned companies and, encouragingly for RPC, especially among architects and other built environment professionals, such as Hayes Davidson, MJP Architects, Stride Treglown, Tibbalds Urban Planning & Design and WATG. These examples cover a range of models of EO.

In 2014, the government introduced two new tax incentives to attract attention to the under-appreciated trust model of EO:

  • individuals who sell a controlling interest in a trading company to an EOT can realise tax-free capital gains provided all relevant conditions are met (see section 236H of the Taxation of Chargeable Gains Act 1992); and
  • going forward, a trading company controlled by an EOT can also pay "all-employee" bonuses free of income tax (but not national insurance contributions) of up to Ł3,600 per employee per tax year.

Tax on its own is unlikely to prompt a move to EO, but it is providing a helpful nudge to consider the idea.

RPC Land & New Homes

In August 2015, RPC converted to EO using an EOT. Randall and Linington sold all their shares in RPC to RPC Employee Trustee Ltd, the trustee of an EOT. A new management team was put in place with directors Graeme Dowd and Kirstie Slaven joining the board and Peter Bowden being appointed as managing director. RPC is believed to be the first real estate agency to become owned by an EOT.

The EOT trustee now holds 100% of RPC's shares collectively on behalf of RPC's employees. Through the EOT, all of RPC's employees have a stake in the ownership, governance and financial success of the business. Randall and Linington continue to provide guidance and support as directors of the trustee and the staff body as a whole has full engagement in the business as employee-owners. EO has secured the independence of RPC and boosted the teamwork on which its success depends. The finance for the EBO came from RPC in the form of contributions to the EOT, which are then paid out to the selling shareholders. The purchase price can be paid in instalments, so as to avoid burdening the business unduly. There are other important practical benefits to an EBO. The founders control the timing and pace of the move to new ownership. There is little disruption to the day to day business of RPC and no commercial risks, in contrast to what a MBO and certainly a trade sale would have involved.

Linington said: "Employee ownership has allowed a smooth transition to hand the reins of managing the business over to the new management team with Peter Randall and I concentrating full-time on fee-earning work." Based on RPC's experience, any owner-manager reviewing their exit options should add an EBO to the list of what to consider.

This article was first published in Estates Gazette on 11 June 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.

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