We have seen a growing number of Employee Ownership Trusts (EOT’s) as an exit strategy for selling shareholders. Not only does this strategy provide significant tax exemptions for selling shareholders (who may qualify for a 0% capital gains tax rate) but also the ability to foster a strong company legacy and increased motivation, productivity and long term stability of the business. Essentially, a qualifying EOT will be established as a trustee company and the selling shareholders will exit by selling their shares to that trust company under a share purchase agreement. The Seller’s exit is managed with sensitivity in the share purchase agreement to ensure future business growth. Sellers benefit “feel good factor” knowing that their employees, as employees of an EOT group, can benefit from being direct stakeholders in the business via share options and receiving income tax free bonuses (of amounts up to £3,600 per annum provided the qualifying conditions are met), rather than left “high and dry” as a result of a sale.

Careful consideration will need to be given to the way in which the EOT is financed. The expected cashflows should be modelled carefully and prudently to determine whether the target company (and its trading subsidiaries) can afford to finance the trust and raise the funds to finance the purchase of the Seller’s shares (and the arising stamp duty). There are a number of ways that this might be achieved, including:

·       The trustee borrows money from a bank.

·       Company borrows money and lends it to the trustee.

·       Company borrows money and makes contributions to the trust.

·       Seller sells shares on a deferred payment basis (vendor finance).

In most cases we’ve seen, the selling shareholder(s) choose the latter, selling their shares to the EOT on terms that the consideration will be paid in instalments. Effectively, the seller finances the deal. Typically, in management buyouts, a seller would require some form of security, usually a charge over the shares. However, an EOT does not meet the controlling interest requirement if there are any arrangements whereby the trustee could lose control without consent (section 236M(1)(d), TCGA 1992) and a charge cannot be granted by an EOT in favour of a former participator (section 236T(4), TCGA 1992). Any charge would therefore need to be over the company's assets, which may not be possible, depending on the company's current level of borrowing and any existing charges.

The trustee of the EOT may finance the purchase by issuing loan notes (IOU’s payable over a long period) to the sellers as deferred consideration. In this case the amount charged to stamp duty should be the nominal value of the loan notes, even though their market value could be much lower, to reflect the fact that the EOT may not be able to repay the loan notes for several years.

The interests of minority shareholders will also need to be considered as part of the decisions regarding funding the purchase of shares by an EOT. If the target company takes on substantial new debt, or commits to funding the EOT to enable it to repay debt, minority shareholders may consider that this is unfairly prejudicial to their interests.

The corporate team at FMGS are well equipped to provide guidance on the pitfalls and risks involved in achieving the balance between Seller objectives and Buyer affordability when drafting EOT documents.  

For more information, please don’t hesitate to contact Nicholas Fielden or Anneka Traynor to discuss.

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