The use of employee ownership trusts (EOTs) is becoming increasingly popular in Wales, and last week the Welsh Government said it wants to see more of them.
Originally launched in 2014 as a tax-efficient way of transferring ownership of a company, EOTs are designed to encourage a more ‘collegiate’ ownership model.
They are attractive to business owners as a way to pass on their companies outside of a normal ‘trade sale’ to a competitor or a management buyout.
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Over the last couple of years, changes in the economic landscape have led many business owners to re-evaluate their circumstances.
As a result, the use of EOTs is on the rise. There are currently 38 in Wales, with 8 created in the last six months alone.
The Welsh Government recently announced it wants to double the number of businesses in Wales that are owned by their employees.
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It’s no surprise EOTs are going mainstream – they are a hugely attractive proposition for many reasons.
So, what is an EOT? Essentially, an EOT is a trust that has to own a controlling interest in the company to achieve the tax benefits for the selling shareholder and the staff.
If the relevant conditions are satisfied, the seller will pay no capital gains when they sell their shares, with no upper limit on the value. Also, employees can be paid an income tax-free bonus of up to £3,600 per year.
Often the key driver is that an EOT allows a company founder to protect their business legacy, to maintain the ethos of the business and their way of running things.
It also allows them to protect the jobs of their staff and keep the business in the same location.
None of these things are guaranteed if the business is sold to a third party.
Also, many owners are reluctant to put their business under financial pressure by taking external funding.
The sale process in an EOT is much easier because the business is being sold to a trust on a ‘friendly’ basis – there’s less paperwork and the sale won’t go through months of due diligence.
There have been some great success stories here in Wales.
We advised Melin Tregwynt, the iconic woollen mill and shop in Pembrokeshire, in its journey to employee ownership earlier this year.
Owners Eifion and Amanda Griffiths handed over the reins to 42 employees of the company.
The mill was founded by Eifion’s grandfather in 1912 and is now a thriving company whose customers have included John Lewis, the BBC, the Tate Gallery and many top hotels.
Now the business has been transferred to the ownership of its 42 employees via a trust, giving them all a stake in the future of the business. This will preserve traditional skills and the knowledge gathered since the company was founded.
Eifion said: “It was important for us that Melin Tregwynt remained a viable business and part of its local community, and employee ownership provided the perfect solution for us.
“We will guide the new management board through the transition, but most importantly the 42-strong workforce will keep their jobs and skills and knowledge will remain here and be kept alive.”
Despite the benefits of EOTs, it’s not necessarily an easy process and there can be practical difficulties to overcome – the main ones relating to funding and management.
When it comes to funding, the EOT has to be funded by someone to buy the shares. Banks might be reluctant to lend to an EOT trustee, so funding usually has to be directed via the company, which might not be able to service additional borrowing.
In terms of management, the business still requires a capable management team to take the company forward – management by committee very rarely works.
So, an EOT can be a good solution for a company owner looking to retire and sell up when there is no obvious third-party buyer.
That is, of course, provided the company has the ability to fund an EOT either directly or via a third-party loan. In some cases, the exiting owner will have to compromise on what they think the business is worth.
However, EOTs have proved to be attractive solutions for selling shareholders as well as the management and employees in “people critical” businesses.
We predict the next few years will see a further increase in the number of EOTs in Wales, as more business owners want to secure their legacies and pass their companies on to the people who helped make them successful.
Andrew Evans is a partner with Geldards based at the firm’s Cardiff office.
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