The increasing interest in employee ownership was reinforced on Wednesday 16 September when our webinar attracted over 60 attendees. Dougie Rae, Partner, EQ Accountants has worked on a number of employee ownership transactions and shared his experience in what was agreed to be a tremendously valuable presentation, followed by a lively Q &A session.
The audience was largely advisers, and as the title would suggest, this webinar attracted mostly accountants. More than half described their knowledge of Employee Ownership Trusts (EOTs) as basic or non-existent. Half had no direct experience of working on an EOT transaction. Encouragingly, more than 60% of advisers who attended said they were likely or very likely to discuss EOTs with their customers following their attendance at the seminar.
Dougie Rae talked through the requirements of the legislation.
To qualify for the Capital Gains Tax relief:
- The company has to be a trading company, or the principal company of a trading group (Trading Requirement)
- The EOT must hold the controlling interest in the company (Controlling Interest Requirement)
- Any benefit must be paid on the same terms to all eligible employees (All Employee Benefit Requirement)
- The number of continuing shareholders who are directors or employees (and people connected with them) must not exceed 40% of the total number of employees of the company or group (Limited Participation Requirement).
Dougie advised that clearance is sought from HMRC to ensure that the 0% Capital Gains Tax rate applies to the transaction.
The process for valuation is exactly the same as it would be for an external buyer; the difference is that, as a non-adversarial sale, there is no tortuous due diligence process seeking reasons to reduce the price.
The presentation was followed by a comprehensive Q&A session, demonstrating a genuine interest in how the EOT, and employee-owned companies, work in practice. The questions and answers are detailed below.
Attendees were asked what barriers they believed to be in the way of wider adoption of EOTs. 49% thought lack of awareness is the major obstacle, with 20% believing it’s a lack of leadership capability within the business with15% ascribing the key hurdle is availability of funding.
Feedback from the session has been overwhelmingly positive with 90% of respondents to the post-session evaluation assessing the webinar as Excellent or Very Good.
A recording of the webinar can be found here:
A copy of Dougie Rae’s presentation is available here: Dougie Rae, EQ Accountants
Questions & Answers
Q: Are the employees required to put funds into the Employee Ownership Trust (EOT)?
A: Not usually. The EOT can sit alongside a share scheme where employees would have the option to invest, but it’s not usual for employees to fund the transaction to any extent.
Q: Are you seeing the EOT being implemented across any specific sector or industry?
A: No. There is a very diverse range of businesses taking the EOT route, covering almost all sectors, company sizes and locations.
Q: From your recent experience do you find business owners have undertaken sufficient personal financial planning when considering their exit and in light of a low yield environment do they know how best to manage their net proceeds as the transaction completes?
A: Difficult to give an accurate answer. Probably fair to say that most individuals do not invest sufficient time in financial planning and maximising monies raised from a disposal.
Q: On valuation, have you seen the HMRC challenge or request any further detail on methodology/multiples used?
A: As far as panelists are aware, to date there have been no challenges on valuations submitted to HMRC.
Q: On an exit from an EOT, are the net proceeds distributed to employees treated as employment income?
A: Expert advice must be sought. However, in the three incidences of an exit from an EOT that we are aware of, two resulted in distributions to employees. In both cases, once the Trust had paid any Capital Gains Tax due, this income to employees was treated as coming from employment and therefore subject to Income Tax. National Insurance must also be paid by both employees and the company at prevailing rates.
Q: Who do you normally see driving the transaction? Presumably the vendors are pushing the transaction as a means of obtaining a sale?
A: Yes, it would normally be the majority shareholders who opt to do this, and then shape the transaction going forward. The driver isn’t always the sale; often it’s because of loyalty to staff, desire for company to remain in situ, or because seller has plans to remain in business and phase their exit, rather than be subject to targets/tie-ins from new business owner.
Q: Shares/bonus/dividends should be based on factors such as time served or salary. Can you provide some further examples and how this works in practice?
A: The legislation is quite specific in how the EOT bonus can be distributed and companies take different approaches to this. The implementation of an EOT does not impact on the company’s general remuneration policy; companies can pay bonuses and award shares as they see fit. Dividends can be paid to shareholders as normal.
Q: How do you see the Scottish Government supporting this and how? Through Scottish Investment Bank or others?
A: All parties within the Scottish Parliament are supportive of employee ownership. CDS has been a key driver of employee ownership in Scotland, and Scotland is unusual in having a funded, dedicated resource.
Q: Have you seen any transactions where bank funding has been available to support the transaction? Would this be raised by the company and then gifted to the trust or can the Trust raise debt itself?
A: There is an increasing appetite for banks and specialist lenders to part fund EOT transactions. It would be usual for the company to take on the loan and gift the cash to the Trust to repay the vendor. So far, in the experience of the panellists, there has not been an instance where the Trust has assumed the loan.
Q: What if seller’s expectations are too high?
A: It is usual for seller’s ideas around valuation to be quite realistic. However, as with any company sale, a mismatch of expectations might lead to an open and frank conversation about what is affordable.
Q: Is there Corporation Tax deductions for the tax-free bonus?
A: Yes, this is treated as payroll and therefore the sum is deductible for Corporation Tax purposes.
Q: What sort of timescales from start to finish in a typical transaction?
A: 2-3 months would be normal, although some companies take longer if there are multiple shareholders, or business demands that must be addressed first.
Q: Could a hybrid model be good for a family business e.g. 51% EOT and 49% in family ownership
A: The EOT structure is quite flexible and it would be quite possible to combine an employee trust with a family trust or direct shareholdings.
Q: Can an EOT still implement a tax advantaged share scheme such as growth shares or an EMI scheme?
A: Yes, quite acceptable.
Q: If dividends are declared by the trading company, then presumably the EOT then acquires a share of the total dividend pot as well as payments to any original shareholders who still hold a small percentage of share capital?
A: It is usual for the EOT to waive its right to any dividend (as it has no requirement for cash) and this money returns to the company to fund the bonus.
Q: What level of due diligence is typically performed on behalf of the EOT to protect their interest?
A: As the former owner is usually remaining with the business in some form until all money is repaid then any due diligence is normally quite ‘light touch”.
Q: Is there full transparency to all staff of salaries in an EOT and does this cause any difficulties?
A: Although there does tend to be increased transparency around company finances this does not usually extend to remuneration. Salaries are usually still confidential within most employee-owned businesses.
Q: What is the current level of CDS support to interested parties?
A: CDS offers a fully funded ownership succession review and employee ownership feasibility study to companies interested in exploring whether employee ownership is an appropriate model for them.
The CDS team is also happy to provide information and signposting to companies and their advisers who may wish to find out more.