Legal view: Having a vested interest

The Covid pandemic and its impact has made businesses of all sizes take a long, hard look at how they operate and what their future holds.

One result of all that soul searching is a rising interest in employee ownership - giving the workforce a vested interest in the company’s future success.

Interest has hit record highs during the pandemic. Figures released in July revealed 250 new employee owned (EO) businesses had been established over the previous 18 months. Today EO companies contribute more than £30bn to the UK’s GDP.

Supporters of the idea say if offers a “compelling option” for improving staff retention, putting employees at the heart of the organisation while delivering a persuasive point of difference to customers.

Research has also shown EO businesses are more profitable and have happier, more engaged and more productive workforces

Peter Kelly, director in the corporate finance team at Blackburn headquartered accountancy firm PM+M, says there has been a spike in enquires from North West businesses looking to potentially convert to an employee ownership structure by selling to an Employee Ownership Trust (EOT).

He says the pandemic is a key driver for the trend as companies look for ways to innovate and put their employees at the heart of their expansion strategies.

The employees are fundamentally the most important part of the business

Peter says: “The pandemic has made businesses of all sizes reassess how they operate. Many now realise that their people are the backbone of their operations so

implementing an EOT model is the next natural step in their evolution – especially as a combination of shared ownership and employee participation can deliver superior business performance.

“We expect more and more companies to explore – and ultimately adopt – this kind of structure as they focus on being as competitive as possible as the Covid recovery kicks in.”

Deb Oxley, chief executive of the Employee Ownership Association, agrees. She says: “We have seen unprecedented growth in employee ownership, with one of the factors being that the pandemic has made business owners think about the future of their businesses.”

An EOT is an indirect form of employee ownership in which a trust holds a controlling stake in a company on behalf of all its employees.

It was introduced in the Finance Act 2014 as part of the then coalition government’s aim of promoting employee ownership as a business model.

Employee ownership companies in the UK include the likes of John Lewis Partnership, Richer Sounds and Arup. Rossendale-headquartered kitchen, bedroom and bathroom manufacturer J and J Ormerod joined them earlier this year.

The family business announced that the existing shareholders had sold 67 per cent of their shares to a newly established EOT, with two trustees in charge.

Following the death of its owner in 2013, the business passed to his three children, including joint managing director Stephen Greenhalgh.

Speaking about the deal at the time, Stephen said: “We looked into private equity or a trade sale but employee ownership seemed the best of both worlds as it secured the long-term future of the business and it also secured our father’s legacy.

"The employees are fundamentally the most important part of the business and now indirectly they are all co-owners and will be able to share in future profits.”

An EOT can be a vehicle for a planned exit, providing the current owners with tax incentives, while protecting the value they have built to date.

Peter Kelly explains: “If the seller sells a majority stake, more than 50 per cent of their business, to an EOT they are not liable for Capital Gains Tax on the sale.”

However, he adds: “While that is an attractive benefit, the tax should not necessarily be the driver for the transaction.

“If all the other factors around an EOT are right, then the fact you don’t pay Capital Gains Tax on the disposal should be a benefit on top. If it’s the reason you are going into it, it is probably not the right thing for you to be doing.”

Peter also says that unlike a trade deal, when the seller may be able to get all their cash on day one, it could take up to eight years for that to happen with an EOT, depending on its structure.

That means it needs to the right fit for the seller’s personal financial circumstances and their future plans. He adds: “If you want all the cash and to just walk straight away than an EOT isn’t right for you.”

Sale negotiations can also be easier and less protracted than in a trade sale. And it can allow the seller to remain involved in the business.

Jenny Pape, tax advisory partner at accountancy practice Azets, says EOT’s can be an effective means of succession planning.

She says: “With appropriate preparation and employee engagement, the EOT model can help deliver a robust, diverse and employee-centred business structure.

“These sales tend to be quicker and smoother than a sale through a third-party purchaser. This is down to fewer negotiations.

“EOTS are increasing in popularity but careful consideration needs to be taken to ensure it is the right strategy for your business; having the right internal culture is a crucial element to ensure success and future growth.

“Encouraging employees to see themselves as business owners can be a powerful tool for recruitment, motivation and retention. Existing directors can remain on the board post-sale leading to a smoother transition.

“One of the most attractive elements of EOT disposals is that a sale can take place without employees having to use their own funds or seek finance, as is often required for employee share schemes.”

While the concept of employee ownership has almost universal support, there has been some concern about potential abuse of the system.

In October, The Chartered Institute of Taxation (CIOT) called for a government review of the EOT tax regime, while also pressing for the removal of unnecessary costs from the process of transferring a company into employee ownership.

Peter Miller, who chairs the CIOT’s owner managed business committee, said there was concern that “some advisers seem to be recommending EOTs as a tax planning measure without any real commitment to employee engagement.”

He added: “In particular, we have heard of advisors recommending EOTs simply as an interim tax-saving step where the intention is, in the relatively short term afterwards, to sell off or float the company.

“This suggests a lack of genuine commitment to employee engagement. We think it is worth exploring ways to guard against this outcome - and the consequent loss of tax revenue.”