The potential downsides of an EOT
Employee Ownership Trusts (EOTs) have gained traction in recent years as an alternative method of ownership succession for business owners. By transferring ownership to a trust which is controlled by employees, they can benefit from a greater sense of ownership, motivation, and financial reward, whilst providing tax breaks for the selling shareholders. However, whilst EOTs may seem like an attractive option on the surface, there are several downsides that business owners should consider before deciding to pursue this route.
One downside is the cost. Setting up an EOT requires legal and professional advice, which can be expensive. Additionally, there may be tax implications that need to be considered, including inheritance tax.
Another potential downside is the loss of control. By transferring ownership to the EOT, business owners will no longer have the same level of control over the direction of the company. The trustees of the EOT are responsible for making decisions on behalf of the employees at the shareholder level, which could lead to conflicts of interest or differences in opinion between the selling shareholders and the trustees (if the existing shareholders are to remain as minority shareholders).
Strict qualifying criteria mean that there is a risk that the capital gains tax relief afforded to the selling shareholders can be lost, and depending on timing may result in the selling shareholders being taxed on the sale, or the EOT itself having a material tax charge, with no liquid funds to settle the liability.
There is also the risk that employees may not be as effective at running the business as the previous owner. Whilst an EOT can provide employees with a greater sense of ownership and motivation, it does not necessarily mean that they have the same level of expertise or experience as the previous owners. This could lead to a decline in the company’s performance or failure to meet targets, which can put at risk any deferred consideration payable to the selling shareholders.
Finally, an EOT may not be suitable for all types of businesses. For example, businesses that are heavily reliant on the expertise of a single individual or a small group of individuals may not be suitable for an EOT. Additionally, businesses that require significant investment or growth may struggle to raise capital through and maintain an EOT structure.
While EOTs may seem like an attractive option for business owners looking to transfer ownership to their employees, it is important to consider the potential downsides before making a decision. Business owners should seek professional advice and carefully consider the financial and legal implications before committing to an EOT.
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This article was contributed to by Martin Adams (Tax Partner) and Adam Muir (Assistant Tax Manager).
Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.