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For a lot of business entrepreneurs, their business is their “baby” – they have nurtured that baby from birth, through each stage of its life cycle and when they exit they wish that baby to continue to survive and flourish in the future.
Very often there are employees who have worked with the entrepreneur for years and have been so key to the success of the company that the exiting entrepreneur wishes to secure their future in return.
In this scenario, an “employee owned business” might then be the key to exit as selling to employees offers the exiting business owner a unique balance of staff continuity while ensuring they themselves realise the value for their business at the same time as securing a legacy for their “baby”.
It also has the advantage of ensuring that the exiting owner can still retain a degree of influence in the business – the reason being that exit can be staged over a number of years.
What does employee ownership mean?
In a nutshell, an “employee owned business” is a business in which a controlling stake is held by or on behalf of all employees.
Usually, the majority of shares are held by an employee benefit trust but individual employees can also hold some shares directly.
How does it work in practice?
Putting it very simply, an Employee Benefit Trust (EBT) is set up by the company. The business owner then sells all or a majority of his shares to the EBT.
The company will also usually set up a tax efficient share scheme such as a Share Incentive Plan (SIP) or Enterprise Management Incentive (EMI) scheme to sit alongside the EBT – this is then used as a vehicle enabling some shares to be given directly to the employees.
As sole owners of these shares, employees will all be personally entitled to vote on shareholder matters and will all individually benefit from capital growth in the share value as well as receiving regular dividend income. These benefits provide a great incentive for employees to work harder because employees themselves will benefit financially as the company grows.
The EBT also facilitates an internal share market in the company and can purchase shares from employees who wish to sell them or who have left the company.
The company’s Articles of Association and the EBT Trust Deed will both regulate the running of the company and ensure that the wishes of the exiting owner are adhered to and that the employees are protected. So, these can be written up to include safeguards for the employees by providing, for example, that certain key decisions such as a sale or relocation of any part of the business, which the board could otherwise make, cannot be made without the consent of the trustees of the EBT or of the employees.
Usually the trustees of the EBT are a combination of the exiting owner, employees, directors of the business and perhaps an external adviser.
The tax advantages
The government is now much more aware of the potential benefits of employee ownership and has introduced a number of initiatives in the past two years to promote this.
The latest, coming into effect as of 6 April 2014 (as proposed by Finance Bill 2014), is a relief from capital gains tax where owners give their shares to qualifying EBTs. Up till this point, where an owner disposes of shares to a trust the disposal is often taxed as if the disposal had been made at market value, even if no consideration was actually paid – however, moving forward, the proposals in the Finance Act 2014 are expected to change this and the shares are instead effectively treated as if they are sold for no gain/no loss. This exemption will help make a sale to employees financially viable for both the exiting owner and the business.
In addition, companies can sometimes claim a corporation tax deduction for shares provided to their directors and employees.
Finance Act 2014 also proposes to introduce an income tax exemption for certain bonus payments made to employees of companies owned by EBTs, where these are not normal salaries.
New rules are also to be introduced to protect the owner from inheritance tax charges where they give shares to EBTs.
So there is a lot happening at HMRC to encourage employee ownership - however a number of conditions need to be met in order to qualify for the tax benefits and is it therefore vital that you take full tax advice before setting up any EBT or employee share scheme.
For more information, contact Carol Wright at firstname.lastname@example.org