Employee Ownership Trusts (EOTs) are the preferred vehicle in the UK for businesses wanting to transfer ownership without sacrificing independence and promoting employee involvement. Introduced in 2014, EOTs allow a company to transfer ownership to staff through a trust that maintains a majority shareholding. While the model has many benefits, the question is: How do EOTs operate as an investment?
What is an Employee Ownership Trust (EOT)?
An employee ownership trust is a trust that holds more than a majority (typically more than 50%) of the shares of a business for the benefit of the employees. Compared to individual direct share ownership, employees gain advantages from the collective shareholding by the trust. The trend has grown popular in the UK, with firms such as John Lewis Partnership and Arup Group adopting the practice. The primary goal is to ensure that employee interests are aligned with the long-term success of the business, creating a sense of ownership and greater motivation for the employees.
Investment Benefits of EOTs
Tax Benefits
One of the biggest reasons entrepreneurs choose an EOT is the tax relief it offers. When a majority stake (over 50%) is sold to an EOT, the sale qualifies for a 0% Capital Gains Tax (CGT) rate. This is a massive tax saving in comparison to a regular sale, when CGT is as high as 20%. Additionally, companies that convert to an EOT can also escape tax on bonuses given to employees, further making the arrangement attractive.
Enhanced Employee Engagement
EOTs typically lead to greater employee participation. When employees are committed to the business, they work better and are motivated since they are interested in seeing the business do well. Increased worker morale has a positive reflection on company performance and the business is attractive to investors. A dynamic staff is typically stable and focused on long-term profitability, leading to greater profitability and lower employee turnover.
Business Stability and Continuity
Another advantage of EOTs is that they ensure business stability and continuity. Through the transfer of ownership to the employees, a business can remain independent and maintain its culture and values. This stability is appealing to investors who prefer businesses with stable management and loyal staff. The risk of takeover by third parties or straying off company direction is minimised and the firm is kept on the correct path.
Considerations for Investors
Though EOTs have several benefits, investors need to carefully consider several factors before investing.
Purchase Price and Valuation
When the sale of a company is to an EOT, the sale price must reflect the market value of the company. An independent valuation is usually conducted to determine this value. Investors must check if the sale price aligns with the company’s financials and growth opportunities. A detailed examination of the company’s current position and potential is necessary to assess if the investment can be justified.
Financing the Transaction
In most cases, the EOT is funded through the company’s future profits and therefore, the business should have enough profits to cover the purchase price. If the business cannot generate enough cash flow, it could get into trouble. Investors need to review cash flow forecasts to see if the business can pay back its debts without compromising its financial well-being.
Decision-Making and Governance
Even though the EOT can have a majority stake, the management of the company on a day-to-day basis is usually left to the existing management team. Nevertheless, the EOT trustees are expected to oversee important strategic decisions. Investors need to understand how decisions are taken and the governance structure since this can influence the direction of the company and its performance.
Potential Risks
Financial Burden
One of the principal dangers of an investment in an EOT structure is financial stress risk. If the company’s profits are insufficient to fund the purchase of the business, the company may suffer from cash flow problems. This may affect business performance and investor returns. It is important to make sure the company has a good cash flow and growth prospects to minimise this risk.
Employee Expectations
While employee ownership may be followed by increased morale, it is followed by staff increasing expectations regarding profit sharing and input in decision-making. If these are not met, it will lead to dissatisfaction or reduced productivity. Management of staff expectations is what guarantees peace and causes the business to operate as anticipated.
Market Perception
Some investors and players in the market may be wary of EOTs because they believe that the focus on employees’ welfare would be at the cost of profitability. This may affect the investors’ attitudes, particularly those who prioritise profit maximisation. Firms with EOTs must be able to articulate persuasively the long-term benefits of such an ownership model and demonstrate how it facilitates sustainable business practices.
Conclusion
Employee Ownership Trusts provide a rare investment opportunity by involving employees, maintaining business continuity and offering significant tax advantages. Nevertheless, as with any investment, careful due diligence is essential. Investors must ascertain a company’s financial health, cash flow projection, governance arrangements and any potential risks before investing. For those seeking safe, long-term returns with a focus on sustainable business practices, EOTs offer a compelling option. The combined impact of tax benefits, improved employee morale and business stability makes EOTs an appealing investment opportunity.
