In the first webinar in the 2023 Employee Ownership Explained webinar series, Graeme Nuttall OBE talked about best practice when it comes to the design and implementation of the Employee Ownership Trust (EOT).
The topic was ‘The employee ownership landscape and view of the future’. You can view the recording of the webinar here:
Graeme was very clear: EOT is a business model, not a mere tax scheme.
Graeme gave some background as to his enthusiasm for employee ownership and detailed the inspirational people and companies who set him on this path. He described the lead up to the statutory recognition of the trust model of employee ownership in the form of the EOT and expressed his surprise and delight that the model had taken off not just in the UK, but was now being adopted in countries across the world.
The Nuttall Review of 2012 identified some of the barriers to the wider adoption of employee ownership in the economy: mainly lack of awareness, perceptions of complexity and the lack of support from professional advisers. Graeme believes these barriers have largely been addressed, and was particularly impressed with how Scotland’s adviser community had embraced the EOT as a feasible option for business owners.
In Graeme’s view, the EOT provides a framework for a transaction. It is for the advisers to shape that framework to meet the needs of the company, balancing the requirements of the selling shareholders and the business with the aspirations of the employees. In the main it works well; to date there have been no obvious examples of abuse.
Graeme paid tribute to the support given by both Scottish and Welsh parliaments to employee ownership as an attractive business model, and did voice some disappointment that the Westminster government currently lacked focus on the topic. His advice to the Scottish parliament would be to look at the US initiatives in building state centres for employee ownership. These federal funded bodies serve as centres of knowledge and support for both prospective employee-owned companies and existing employee-owned businesses. Graeme believes that having a dedicated minister with employee ownership in their portfolio helps keep it on the agenda. Norman Lamb was the first Minister in Westminster to have this brief and was instrumental in paving the way for the introduction of the EOT. Tom Arthur MSP, and Minister for Public Finance, Planning and Community Wealth currently holds that role within the Scottish government as co-chair of industry leadership group, Scotland for Employee Ownership. Graeme praised the efforts of Co-operative Development Scotland (CDS) in ensuring employee ownership remains a priority for Scotland.
Many other countries are looking to replicate the EOT and Graeme has been involved in advising on how the structure can be adapted for different jurisdictions. It is expected that Canada will have something in place by the end of this year, and Denmark is exploring the model. Australia already has its first EOT in place and there are efforts to simplify the tax position to encourage more.
Graeme’s advice to Scottish advisers is to keep doing what they are doing. Many countries are looking at the success in Scotland and striving to emulate that. There are some excellent examples of successful EOT owned companies in Scotland and advisers are to be congratulated on the quality and integrity of the advice and support offered. It is important to remain true to the principles of employee ownership and guard against complacency and potential abuse.
A useful discussion followed the presentation. See below for a note of the audience question and answers. The answers do not provide advice and professional assistance may be needed before deciding what to do in particular circumstances.
Questions and Answers
Q. Canada and Australia are introducing employee ownership models after learning from the EOT experience in the UK. In order to further develop the UK EOT model are there non-UK models we can learn from?
A. Yes, there’s a wealth of non-UK employee ownership experience. In particular, the American Employee Stock Ownership Plan or ESOP, when it works well, delivers high rewards to employees on retirement. We need to consider if there are other more challenging and regimented ways of sharing profits with employees than the discretionary annual EOT bonus.
Q. Do you see the tax exemption ending on sales to an EOT?
A. This would seem unlikely given the policy has got a long way to go to grow UK employee ownership and also because EOT ownership is exceeding its policy aims. EOT owned companies showed resilience during COVID-19, they are helping to manage the cost of living crisis without industrial action and achieve other policy aims beyond those envisaged in the Nuttall Review.
Q. Is the right to appoint directors and trustees (usually themselves) a contravention of the control requirement in EOT legislation? What about when this right extends beyond the restricted period of deferred consideration?
A. Advisers should be confident, without having to rely on detailed legal or tax analysis, that the trustee of the EOT has genuine independent control of the trading company. The composition of the board of directors of a trustee company is important. My preference, especially after the deferred consideration period, is the “paritarian” model with a balance of employees and executives together with an independent trustee. The former owners may have much to offer the company, particularly during the early years of employee ownership, but it is important that there is a demonstrable change of control to EOT ownership. We do have flexibility and it is up to advisers to ensure this is not abused.
Q. How would you structure the membership of a corporate trustee that is a company limited by guarantee and why?
A. I developed the company limited by guarantee (CLG) trustee solution because I believe it works best for various reasons. It is important in the running of the trust to have only one decision-making group. Whoever is on the CLG board would also therefore be the members of the CLG. If, say, a members’ decision is needed over changing the name of the CLG, it would be the same group of individuals making that decision as make board decisions. This approach also makes the trust arrangement much easier to explain to employees and others. If the trading company is the trustee shareholder then the trustee may not be sufficiently independent. Variations are possible, but I am more comfortable with this CLG structure.
Q. Do you agree that the equal gifting of spare EOT shares, to eligible employee-owners, would be a radical and progressive approach for Employee-Owned companies, where at least 51% of shares would remain in Trust?
A. There is a strong brand around the EOT which is centred on collective long term employee ownership. I believe it would detract from that brand if an EOT is also used as a warehousing or other share plan trust. It would be more effective to put in place a separate trust, such as a share incentive plan, to provide individual share ownership arrangements. But I agree that “hybrid” employee ownership models should be considered more than they are. Something we are recognising, for example, is that you may have to incentivise key managers, who are going “above and beyond” during the deferred consideration period, and so an executive incentive plan could be appropriate.
Q. Can the establishment of circa 1,100 EOTs in 10 years be described as successful? What is ‘success’ over the next 10 years with regard to EOT numbers?
A. The EOT was introduced in 2014. It has been successful, in particular, in making employee ownership a mainstream idea. As to the next few years, there are various measures of success out there. I’d like to overtake the number of ESOPs in the US, currently just under 6,000, as our next milestone. Then we can say we are clearly making a difference.
Q. Can you briefly summarise the main tax benefits of an EOT?
A. If a controlling interest in a private trading company is sold to an EOT, subject to certain conditions, then the transaction is free of capital gains tax. If the majority shareholding of a company is in an EOT then the company, subject to certain conditions, can pay income tax free bonuses to all employees of up to £3,600 per employee in a tax year.
Q. Do you feel, Graeme, that creating an EOT is a barrier to potential future acquisition of that company on the grounds that “for the benefit of all employees” is too vague (that is, too difficult to devise a monetary value upon which trustees can agree to a sale?)
A. The purpose of an EOT is to create long term employee ownership, providing benefits for all employees, present and future, on a same terms basis. A significant motive for many business owners who take this business succession route is that the EOT does provide a barrier to a future sale. A trust deed can be drafted so as to make it very difficult for a company to lose its independence.
Q. I have a question that has to do with the enterprise level (as opposed to policy). I’m curious to know about the question of leadership development and leadership succession in EOTs. What is working? What challenges are there, in terms of cultivating and preparing a next generation to lead the firm, now under employee-ownership, once the seller(s) have exited management.
A. This is a topic for a standalone webinar. Leadership succession must be considered ahead of a move to employee ownership. In some cases, employee ownership is put on hold until there is a management team ready to run an employee-owned business. Obviously, it’s not just that next generation, but the one after that and so on. There can be difficulties especially in smaller businesses finding the right manager or managers, although that’s probably true whatever the ownership model. If anything, it’s easier with an EOT business model because the next generation do not have to buy their way in to a senior role. It is vital that managers “get” employee ownership: that’s fundamental. Sector experience is positive with examples of both successful internal promotions and external recruits. Some companies report they get a higher-calibre of applicant now they are employee-owned.
Q. From my experience, a recurring theme to emerge from those businesses who have transitioned to employee ownership is that those in leadership roles are sometimes dissatisfied to the extent that they participate on the same basis as every other employee and they feel their contribution goes unrewarded. What are your views?
A. Many management teams report that the EOT motivates staff to an extent it makes the management role more fulfilling. But I understand this point. Everyone should receive competitive market rates of reward. This can include individual performance bonuses or other incentives as well as benefitting from the all-employee “EOT” bonus. It may be worth considering a separate share plan to incentivise and reward the key contributors in the business, subject to EOT trustee scrutiny.
Q. How vital are independent trustees? I often get “resistance” from the management board.
A. I have to declare an interest. I am an independent chair and trustee director of a number of employee-owned companies. I am convinced of the importance of the role of the independent director. Employees and managers are busy doing their day to day jobs. It’s really only the independent director whose job it is to make sure that the EOT ownership and governance arrangements are working well: that the company is encouraging genuine employee engagement, sharing profits equitably and providing good work. There is usually a fee involved but it is the only significant cost of running an EOT and the benefits can’t be underestimated. Read more of Graeme Nuttall’s views on independent directors in the article Nuttall Shares: On the role of the independent trustee director – Ownership at Work.
Q. Please elaborate on the downside of having an offshore trustee versus the benefits of a UK based Trustee?
A. My personal experience of offshore trusts that control family trading companies is not good. This is not a reflection on the quality of the individuals involved. These professional trustee companies are heavily regulated and there is a reluctance to make decisions that another board of directors would make quickly, without going through a convoluted process requiring extensive consultation and expensive and time-consuming professional advice. This can be avoided if there is a UK trustee company with the right composition of individuals on the trustee board who can respond to issues directly.
Q. What might be the factors for consideration for a 100% EOT owned business to embrace a direct share ownership over a minority shareholding amongst a small number of its employees? How might the direct ownership of shares by a small number of people be couched in terms of being for the benefit of all the employees i.e. after the conversion of a business to a 100% EOT has already taken place
A. The terms of the EOT trust deed or other terms of the EOT transition may prohibit this. The practicalities and potential benefits need careful review. A small percentage of EOT owned companies put a share plan in place once the EOT transaction is complete, either an all-employee plan such as a share incentive plan or a selective plan. There can be good reasons for doing either or both that are entirely consistent with EOT ownership. In relation to a plan that benefits only a few a strong case is needed for doing that. Even a share incentive plan may be inappropriate if only a few will benefit from it (and it will reduce the all-employee bonus). The trustee would need to be convinced it is in the interests of all employees to dilute their shareholding and allow this to happen. Replies to other questions mention incentivising key individuals during the deferred consideration period and providing competitive market rates of reward.
Q. We all know about the £3,600 qualifying bonus payments that can be made to eligible employees each tax year, but are there other generally accepted routes to distributing profits of the EOT owned company among the employees over and above the £3,600 payment?
A. The £3,600 amount is not a limit. Taxable all-employee bonuses can be paid that exceed this amount. Many employee owned companies consult their employees on the use of profits. Funds may be kept back in reserve in case bonuses in future years need topping up, profits may be used to finance charity and community activities or spent on employee development and training. It is possible to establish a share incentive plan and use it to provide tax-free share awards each tax year. The practicalities and fairness of this need careful consideration as mentioned in replies to other questions. Remember I asked the UK Government to introduce the “EOT” income tax free bonus to avoid the need for a 100% employee trust owned company to introduce a share plan.
Graeme Nuttall OBE is a partner at European law firm Fieldfisher and as the UK Coalition Government’s independent adviser on employee ownership authored the ‘Nuttall Review of Employee Ownership’. The EOT was introduced as a result of the findings of the Nuttall Review.