A record number of companies are setting up employee-ownership trusts as founders look for alternative ways to reward staff and sell their stakes while also benefiting from a tax break.
Nearly 500 employee ownership trusts were set up in the 12 months to the end of September, a freedom of information response has revealed, a sharp increase from 235 established in the previous 12 months and just 56 the year before that.
Simon Blake, partner at accounting firm Price Bailey, which submitted the FOI request, said a difficult funding environment has made the option of selling to employees with tax incentives more attractive, and staff shortages have driven founders to look for ways to “attract and motivate staff” without having to pay money upfront.
Employee ownership trusts, known as EOTs, were introduced in 2014 to encourage more shareholders to set up a corporate structure similar to the John Lewis model, where staff are partners in the business.
EOTs enable business owners to transfer tax efficiently a stake of at least 50 per cent of company shares into a trust which has the firm’s employees as its beneficiaries. The founders are then paid back gradually through company profits, often with the company taking out a loan to fund a contribution to the EOT to provide business owners with an initial upfront payment.
Lisa Hayward, partner at Birketts, a law firm, said changes to tax rules in 2020 which slashed the amount of capital gains tax relief that entrepreneurs can claim on selling a business from £10mn to £1mn “definitely sparked” greater interest in EOTs.
Business owners can sell to an EOT free of capital gains tax, and each employee can share in up to £3,600 of profits a year free of income tax.
Matthew Emms, a partner at accounting firm BDO, said: “People were initially nervous of the structure, but a lot have worked out really well, becoming a self fulfilling prophecy.” He added that banks have become increasingly comfortable lending to companies looking to set up an EOT.
Danny Sims, founder of DJS Research, a market research agency, with more than 100 members of staff based in Stockport, Cheshire, sold 65 per cent of the business he set up two decades ago to an EOT last year.
“I didn’t want the company to be swallowed up as part of a bigger group, I wanted to keep the legacy of an independent company,” he said. He added that in a recent survey 99 per cent of staff said they were happy with the new structure.
Employee ownership trusts are particularly popular among professional services firms, which make up nearly 40 per cent of the total, according to the Employee Ownership Association, which represents employee-owned businesses.
But other sectors are following suit. High-profile transitions from treetop adventure business Go Ape in 2021 to hi-fi retailer Richer Sounds in 2019 and organic veg firm Riverford in 2018 have played a “really big part” in the growth of EOTs, according to Francesca Lord, the EOA’s head of communications and policy.
She added: “Since the pandemic started, many business owners have been reflecting and thinking more about succession . . . and people have become more aware that employee ownership is a great way to weather difficult times.”
Malcolm Hurlston, founder of The Employee Share Ownership Centre, an organisation which promotes employee ownership of businesses, described EOTs as an effective way of retaining staff when a business is sold, strengthening the management and providing stability in communities. “It’s really very important for communities and can help contribute to levelling up,” he said.
EOTs, however, are not a panacea. Hurlston said a disadvantage is that they can be “a bit restricting” when there are likely to be many other people who contribute to the success of a business but who are not employees who will not benefit from the trust.
They can also create frustration among businesses if founders have been paid out and won’t let go, or if they sell out quickly leaving the business with debt to pay off and if managers are unfamiliar with the structure they could be at risk of triggering a “disqualifying event” which could leave the business with a large tax charge.
However, research suggests that transferring shares to an EOT can make businesses more productive. Paul Fish, director at building services company P A Collacott, which was established in 1978 and has around 75 permanent employees, said that when 51 per cent of the company was sold to an EOT in 2021 it “definitely boosted productivity” by bringing a “change in the attitude to some staff”, despite the fact employees will not benefit for around five years while company profits are spent on paying out the founders.