Employee Ownership has the Scottish Government’s attention, accounts for just under 140 businesses in Scotland and is said to positively impact on productivity, absenteeism and business growth - but what is it, what benefits does it offer, and is it the right fit for your business?
What is an employee-owned business?
An employee-owned business is one where its employees directly or indirectly (through the operation of a trust established for the benefit of employees) hold a majority of shares in that company.
Why is it relevant?
The answer here is two-fold.
Despite all the recent press attention, employee ownership has actually been around for some time and so is a tried and tested business model – one which is also said to boast increased efficiency, productivity, inclusion and innovation. The premise of the business model is that employees having a stake in the business will incentivise them to drive the success of the business and have more fulfilling and engaging employment. Employee ownership could therefore be an attractive structure to any start-up business.
But it is arguably its place as an exit strategy that has seen the recent surge of businesses becoming employee-owned in Scotland. This is because it allows owners to exit on terms which are tax efficient, aligned with their objections and which can safeguard jobs.
How is it structured?
Employee-owned companies can be structured in one of three ways, each with its own pros and cons.
The three structures are:
- Direct Ownership
This is where employees become individual shareholders and physically hold shares in the company. Benefits of this include cheaper set-up costs and employees feeling directly engaged in the future of the company. However, direct ownership offers no specific tax advantages, and the mechanisms for transferring shares each time an employee moves on can be unwieldy.
- Indirect Ownership
This is often referred to as the “John Lewis” model and is where shares are held collectively on behalf (and for the benefit) of employees through an employee ownership trust (EOT). Although this option may not feel as real to employees, it is administratively simpler and offers more stability (as the trustees are bound to the objectives set out in the EOTs trust deed). It also allows the EOT to pay tax free bonuses of up to £3,600 to employees annually, should the EOT meet certain qualifying conditions.
- Hybrid Ownership
This model is a combination of direct and indirect ownership and is where some shares are held by an EOT and others by individual employee shareholders. Hybrid ownership offers the best of both and so allows a means for owners to scale down their shareholding over time and make a phased exit from the business (which might be good for continuity) or for new shares or share options to be offered to new management to attract or incentivise the new driving force of the business.
The form of ownership to be used will depend on whether you are starting a new business or are seeking an exit. For an exit, this will usually be achieved by the founders selling all of their interest or a controlling interest in the company to the EOT and so will usually be structured through indirect or hybrid ownership, depending on whether the owners wish to exit over a phased period.
What are the benefits?
Among the benefits to the business, economy and employees (in terms engagement and and financial wellbeing) alluded to above, if certain qualifying conditions are met, there are also some tax benefits to an employee ownership structure, and these include:
- Full capital gains tax relief for the owners on the disposal of a controlling interest (i.e. more than 50%) to an EOT; and
- Employees benefiting from a tax-free bonus of up to £3,600 annually.
Is it the right fit for my business?
It depends.
The question of whether employee ownership is right for your business (whether at the outset or on an exit) will be subject to a number of factors and it should be considered in the round alongside other matters such as the financial climate at the time (a trade sale may offer better financial return to a seller), the nature of your business (an EOT would usually acquire a business that is a company and so may not be suitable if your business is a partnership, and it may also not be aligned with your objectives), tax, the employees and funding (an EOT will usually finance the purchase using existing and future cash reserves or through external funding).
If succession planning is on your mind, then a sale to an EOT could be an option. It may not be the right fit for everyone, but it should have its place on the table alongside the other more typical options of a trade sale or management buy-out.
How can we help?
Our corporate team has a wealth of practical experience in advising and supporting clients wishing to transition to employee ownership through having advised on a significant number of employee ownership transactions in the past few years. If you want to explore how employee ownership might work for you and your company, please contact Neil McWilliam, Chris Byrne or Chris Allan for an initial discussion.
