There are three principal reasons why this might happen, as follows:
Firstly, it is now possible to structure such a sale in a way that means that the seller of the business will pay no capital gains tax on the proceeds of the sale.
Secondly, many business owners feel that they would like to leave a legacy and a sale into employee ownership may be the best way to achieve that.
Thirdly, there is increasing evidence that employee ownership is a very successful and stable business model.
Following a recent change of legislation implemented through the Finance Act 2014, it's now the case that if a controlling interest (typically a majority shareholding) in a company is sold to a new type of trust (an “Employee Ownership Trust” or "EOT") then a special exemption applies and there is no capital gains tax payable.
There is also one other very attractive tax break, which is that once a company is established with such a structure, the company can pay bonuses of up to £3,600 per annum to each employee without income tax applying to those payments (although National Insurance does). This has proved a popular incentive, particularly in companies with a high number of relatively low paid employees.
An EOT will usually be established with a trustee which is a subsidiary of the company and appropriate company representatives will form the board of the trustee company. It is likely that the EOT will have borrowed (either from external funders or from the seller by way of deferred consideration) to fund the purchase and it will therefore use the dividends it receives on its majority shareholding in the company to pay down that debt over a period of time.
The form an EOT has to take is fairly strictly specified and has to provide, more or less, for equal treatment of all the employees as beneficiaries, although there can be some variations, for example based on relative salaries.
It is possible for the EOT to own 100% of the company or there may be other individual minority shareholders. The two models are known as "indirect" employee ownership (where there is a trust holding shares for the benefit of employees) and "direct" employee ownership where individual employees hold shares in the company. The advantage of indirect ownership is that there is no need to be concerned with transactions in the shares held by individual employees as they come and go. However, in passing, it is worth noting that employee owned companies generally enjoy very low rates of staff turnover when compared to industry averages.
There are a growing number of founding shareholders of businesses who take the view that the environment they have created is something special and that this can best be retained by passing the company into the ownership of the employees who have grown up in that culture. This is in stark contrast to what typically happens on a sale to a trade buyer, where clashes of culture and strategy are not uncommon, although it would be fair to say that there are some businesses skilled in handling such integration properly.
Sir Charlie Mayfield, chairman of the John Lewis Partnership, speaking in March 2015 contrasted the current “feel good” in the economy with the challenges of low pay and productivity, adding that the UK was "job rich but pay poor". Sir Charlie cited his belief that employee owned businesses are well placed to counter this challenge through their desire to focus on the social purpose of work in order to drive greater productivity leading to higher pay. He believes this focus means creating more ways for staff to engage in their business, to ensure that they are able to make a more meaningful contribution.
Ian Hasdell, chairman of the Employee Ownership Association, recently commented that "employee owned businesses are, as a direct consequence of their ownership model, out performing all of the types of business in every part of the economy". The number of employee owned businesses continuing to grow at an annual rate of around 9%. It's estimated that the sector is now approaching a similar scale to the aerospace industry in the UK.
One of the key consequences of the employee ownership model becoming more common is that banks and other funders are becoming more comfortable with lending to such businesses. This will facilitate more transactions where businesses are sold by their founders into ownership by employees.
The legal mechanics required to transfer to and set up an employee owned businesses can, at first glance, look somewhat daunting. However, the required structures are based on a combination of well established areas of company law and trust law and typically have corporate governance infrastructure that could reasonably be regarded as exemplary.
If you would like either a preliminary general discussion or individual detailed advice on any aspect of employee share ownership, please contact either Melanie List or Jonathan Oxley of Lupton Fawcett's Employee Share Ownership Team.
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