By Andrew Evans | Geldards

The use of employee ownership trusts (EOTs) to transfer ownerships of companies is becoming increasingly popular in Wales.

Originally launched in 2014 as a tax-efficient way of transferring ownership of a company, EOTs are designed to encourage a more ‘collegiate’ ownership model.

They are attractive to business owners as a way to pass on their companies outside of a normal “trade sale” to a competitor or a management buyout.

In the last year, the pandemic, combined with fears over potential changes to capital gains tax (which never happened,) have led many business owners to re-evaluate their circumstances.

As a result, the use of EOTs is on the rise. Last year, five companies in Wales transitioned to employee ownership. So far we this year we have advised on three in the last three months alone.

And it’s no surprise EOTs are going mainstream – they are a hugely attractive proposition for many reasons.

So, what is an EOT? An EOT is a trust that has to own a controlling interest in the company in order to achieve the tax benefits for the selling shareholder and the staff.

If the relevant conditions are satisfied, the seller will pay no capital gains when they sell their shares, with no upper limit on the value. Also, employees can be paid an income tax-free bonus of up to £3,600 per year.

Often the key driver is that an EOT allows a company founder to protect their business legacy, to maintain the ethos of the business and their way of running things.

It also allows them to protect the jobs of their staff and keep the business in the same location.

None of these things are guaranteed if the business is sold to a third party.

The sale process is also much easier because the business is being sold to a trust on a ‘friendly’ basis – there’s less paperwork and the sale won’t go through months of due diligence.

There have been some great success stories here in Wales.

We advised award-winning Cwmni Da, a TV production company based in Caernarfon, North Wales, in its journey to employee ownership in 2018.

Co-founder and managing director Dylan Huws wanted to keep the company in the control of the people who helped make it a success and maintain the production base in North Wales.

A third party could have easily bought the company and shifted assets and production elsewhere, but the move secured 50 well-paid and highly skilled jobs in North Wales.

Last year we advised Heinnie Haynes, a South Wales-based mail order business on its transition to employee ownership.

Founded in 1996, the company sells outdoor kit and specialist knives. As the business needs little more than a warehouse to operate, a new owner could have simply moved the stock to another location.

Founder Bruce Bollington wanted to protect his legacy and keep his 15 staff employed, so to show his trust in his workforce he sold the company to them.

Despite the benefits on EOTs, it’s not necessarily an easy process and there can be practical difficulties to overcome – the main ones relating to funding and management.

When it comes to funding, the EOT has to be funded by someone to buy the shares. Banks might be reluctant to lend to an EOT trustee, so funding usually has to be directed via the company, which might not be able to service additional borrowing.

In terms of management, the business still requires a capable management team to take the company forward – management by committee vary rarely works.

So, an EOT can be a good solution for a company owner looking to retire and sell up when there is no obvious third-party buyer.

That is, of course, provided the company has the ability to fund an EOT either directly or via a third-party loan. In some cases, the exiting owner will have to compromise on what they think the business is worth.

However, EOTs have proved to be attractive solutions for selling shareholders as well as the management and employees in “people critical” businesses.

We predict 2021 will be a bumper year for EOTs in Wales, as more business owners want to secure their legacies and pass their companies on to the people who helped make them successful.