Employee ownership is on the rise in the UK, but many business owners will not consider employee ownership when looking to sell their business, and their decision may possibly have been influenced by employee ownership trust (EOT) myths. In this article, we tackle four of these common myths.
Why Myths Hold Business Owners Back
Business owners who have considered selling their business to an EOT but decided against it might have considered one or more of the following common misconceptions about employee ownership:
- “I’ll lose control of my business immediately”
- “Employee ownership isn’t financially viable”
- “It’s too complicated and risky”
- “Employees won’t understand or care about ownership”
Correcting these myths matter when planning a sale of a business because a transition to employee ownership might be the best option for a business owner, but due to these myths they might not fully explore it.
And if an owner is considering an EOT, then addressing these misconceptions early can help make the sale of their business and transition smoother because it helps them to explain to their leadership team and employees exactly what employee ownership is, and what it is not.
Myth 1: “I’ll Lose Control of My Business Immediately”
It is the directors (rather than the shareholders) who have day-to-day control of the company, so the sale to an EOT does not mean daily control shifts to the employees or trustees. The EOT’s role is to make sure the company is being run in the best interests of the employees – but it is the directors’ role to actually run the company.
It is common for founders to remain a director of the trading company even after the transition to employee ownership (and given there may be a considerable amount of money owed to the founder by the EOT which is funded by the company, this is understandable).
If the founders have received tax relief on their sale proceeds, there are though restrictions on the number of founders who can be trustees or if there is a corporate trustee (this is very common) on how many can be directors of the trustee company and the extent of the founders’ control over the EOT.
Although the tax legislation prevents a founder from having control over the EOT company, it is possible for the sale agreement to contain a list of certain actions which the trading company cannot take without the founder’s consent. This can allow the founder to have a say on matters which might otherwise drain value from the company and interfere with the ongoing repayments to the founder.
Myth 2: “Employee Ownership Isn’t Financially Viable”
The majority of EO transitions are funded by a combination of existing cash in the business, and the founder deferring the remainder of the sale price over a number of years. Although not all of the sale price is received at completion, ownership of the business will transfer to the EOT immediately, so the founder has effectively loaned a significant portion of the sale price to the EOT. The EOT then uses the future profits of the business to finance the repayments to the founder.
There are some banks and financial institutions which will lend cash to the EOT to purchase the shares, so that the loan is with an external third party rather than the founder, but the lending market for EOTs is still in its infancy so this is not widely available.
Founders can receive whatever price is agreed between them and the EOT, and this could be the market value for the company. There is though a requirement that if the founder wants to receive tax relief on the sale proceeds, the EOT must take all reasonable steps to ensure they are not paying more than the market value for the shares.
Provided that certain criteria are met, it is possible for founders to pay no capital gains tax on the sale proceeds for selling their business to an EOT. This compares to a sale to a third party where the CGT rates could range from 14-24%.
Myth 3: “It’s Too Complicated and Risky”
EO transitions are still a relatively new thing, with the current legislation being only a few years old. The considerations (both for the transition itself and the operation of the business when it is employee owned) are very different to those of a traditional sale to a third party. It’s therefore important for founders to engage lawyers and accountants who are experienced in EO work, and the nuances that come with it.
A perceived risk for founders selling to an EOT is that they will lose control over the business, which can be a particular worry where a significant portion of the sale price is deferred over the next few years. As discussed above, it is possible (and common) for the founder to remain a director of the trading company to continue their involvement in the operation of the business until their deferred consideration is fully paid.
A perceived risk for employees is that the founder massively overvalues the company, and saddles the EOT with a monstrous debt which it cannot pay. This is prohibited under trust law. Employees are now further protected by the tax legislation, as for the founder to receive the tax relief, the EOT must take all reasonable steps not to pay more than market value for the company. Therefore, any founder looking to extract more than the true value of the company would be liable to pay a significant amount of tax.
Myth 4: “Employees Won’t Understand or Care About Ownership”
Employee ownership, indeed, many facets of running a business, might not be known or understood by employees, so how and what is communicated about employee ownership is very important if they are to understand and care about business ownership – and from our experience they will care when they are able to understand.
Businesses can begin to effectively communicate what employee ownership is by considering what information ‘owners’ need to know to make informed decisions, review how frequently that takes place if at all currently, and then build up employees understanding and accessibility of that information.
Research undertaken by the Employee Ownership Association (eoa) shows that employee owners have greater engagement and motivation, are that translates ultimately to them being more productive – all of which improves the business.
Employee ownership can unlock ‘people-powered growth’, but it does not happen by default. The culture and leadership of an organisation are crucial to the success of a business if it transitions to an EOT. In part that is because people are told they are now ‘owners’ of the business but if they don’t experience that from their business and their leaders then it rings hollow and can run the risk of reducing rather than increasing engagement – you’ve got to walk the talk.
Ensure your leadership team understand and support the transition, so that they can explain and reassure employees and ensure that employees understand what the transition means for them, and how and when they will be engaged and won’t be engaged. Lack of clarity creates a vacuum of information where incorrect assumptions breed.
Our Experience: 9 Years as an Employee-Owned Law Firm
We’re proud to have been the first large law firm in the UK to transition to employee ownership in 2016. In that time, we’ve helped other businesses transition to employee ownership and been able to guide them based on our experience.
We believe our support is unique in that aspect; we know what it feels like firsthand to be employee owners. Transitioning to an EOT has a legal aspect but it also requires cultural and change management considerations.
Due to the myths that surround employee ownership, it is common for employees to be skeptical when they hear about the transition, fearing that they will have to personally pay for their shares, or may suddenly become liable for the business’ debts. When requested by founders or the company, we will attend meetings where the transition is announced to staff, so we can answer questions and reassure employees that they have no personal liability and that there is no real downside for them.
Conclusion: Why Tackling Myths Early Leads to a Stronger Transition
Ultimately, business owners should explore all options available to them when selling their business. What works best for them? What supports the business to continue to grow and succeed?
Selling their business to an EOT should be an option that is more widely understood and considered by business owners, but it won’t be the right step in all circumstances.
If employee ownership is the right option, then overcoming these four myths we’ve tackled will set the stage for a smoother EOT process.
And, if a business owner is considering employee ownership, then we’d like to support you on your journey. Please contact our team on 0345 450 5558 or enquiries@stephens-scown.co.uk and we can explore all of the options available to your business. Or you can reach out to the authors of this article; Sam Moles and Dave Robbins.