When we are talking to a business owners about selling their company to an employee ownership trust (EOT), they often say they’ve been told by others that they can sell to an EOT, be paid for it, and still retain control.
Well, if this sounds too good to be true, that’s because it is. It is clearly NOT permitted in the EOT legislation.
However, that doesn’t mean you can’t retain some level of involvement or influence.
Let’s explore further and find out the true legal position, what’s prohibited and to what extent can an owner who sells to an EOT retain influence and protect their legitimate interest of being paid.
What do the tax rules say?
If you sell to an EOT and want to claim:
- Capital Gains Tax exemption on the sale and/or,
- income tax free bonuses for employees after the sale
then the rules are clear – the EOT must have a controlling interest in the company. This means it must:
- hold more than 50% of the company’s ordinary shares
- hold a majority of shareholder votes
- be entitled to more than 50% of profits and assets on a winding up
(Section 236M Taxation of Chargeable Gains Act 1992 and Section 312E Income Tax (Earnings & Pensions) Act 2003)
The majority of shareholder votes requirement makes it crystal clear that the EOT must have voting control of the company, which amongst other things gives it power to decide who are the company’s directors from time to time.
So the key takeaway is that once you sell your company to an EOT, you will no longer legally control it.
What if the EOT doesn’t pay? Can you retain security over the shares?
A common follow-up question we get is whether selling shareholders can take security over the shares they’ve sold – so that if the EOT doesn’t pay the agreed purchase price instalments, they can reclaim ownership.
Again, the tax rules are clear: this is not permitted. You must give up ownership – and with it, the right to reclaim shares – if you want the tax reliefs.
What happens in practice?
Although legal control passes to the EOT, many founders continue to play a leading role in the business for some time after the sale. There’s no requirement for you to step down as a director immediately – and in fact, many companies benefit from continuity of leadership while a longer-term succession plan is developed.
In most cases, EOT trustees and employees welcome this. It provides stability and ensures that the business continues to thrive. It would be foolhardy for founders to step back as directors without the right kind of competent people to take the business forward.
However, the trustees do have the power to make changes to the board – and may exercise this if leadership becomes dysfunctional. For example, a founder who continues as chairman but constantly interferes with the new managing director’s decisions, refusing to ‘let go’ may destabilise the leadership team and business. In such cases, trustees may have a duty to step in.
How can you retain influence?
Although you must give up control, there are still legitimate ways to protect your interests and stay involved:
- Reserved matters in the sale agreement
The contract between the founder(s) and EOT trustees for the sale of the company will often contain a number of “reserved matters”: these are actions the company (or EOT) may only take with the selling shareholders’ permission until they have been paid in full. They should strike a balance between allowing the directors to run the company on a day to day basis without seeking seller permission, but would require it before the company could do anything out of the ordinary course of business and/or unusually costly.
- Serving as an EOT trustee
It is also possible for the EOT trustees to include one seller (although sellers and their relatives must comprise less than 50% of trustees), at least until sellers have been paid. It can be useful for the trustees to have the benefit of the seller’s knowledge. Whilst the duty of every EOT trustee is to act in the best interest of the beneficiaries (so a seller-trustee must not use that role to protect their own interests), they may feel there is a continuity advantage in remaining connected to the company in this way, particularly if they are stepping down as a director
So can you sell to an EOT and retain control?
In short, no. If you sell your company to an EOT, you are giving up control. That is the quid pro quo for being paid and claiming exemption from CGT tax. In practice, though:
- you can generally continue as a director for a while, if this benefits the company.
- you can retain some limited say over proposed company actions that could adversely impact your ability to be paid through reserved matters in the sale agreement, and
- you may be able to act as a trustee – so long as you remember that your duties are to the beneficiaries.
Thinking About Selling to an EOT?
We’ve helped nearly 200 businesses successfully transition to employee ownership. If you’re considering an EOT and want to understand your options for staying involved while getting paid fairly, we’d be happy to talk.
Contact us today to explore whether an EOT is right for your business – and how to do it the right way.
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Want to discuss your employee ownership options and see if its right for your firm? Please contact us for a no-commitment discussion on 02038189420 or email info@postlethwaiteco.com.