There are some famous names that back the concept – retailers John Lewis and Richer Sounds, professional services firm Arup, architect Hayes Davidson, and West Highland Free Press which joined the movement in 2009 when the paper’s 10 employees bought the company from the five founders.

A principle defined

Steve Halkett, head of corporate at Wright Hassall, says that there are two types of EO: direct ownership of shares by employees via traditional share schemes and indirect ownership by employees through an employee ownership trust (EOT) structure. On top of that is a hybrid of the two.

On EOTs, Philippa Dempster, managing partner of Freeths, explains that “an EOT is a special form of employee benefit trust introduced by the government back in September 2014 in an attempt to encourage more shareholders to set up a corporate structure similar to the John Lewis model”.

She adds: “The aim was to enable wider employee ownership of a business so that employees could benefit from the success of the company by sharing in the profits in proportion to their holding.”

Procedurally speaking, Dempster says that the owners of the company sell their shares to a trustee company under a share purchase agreement and employees buy shares, if they want to, from the trustee company, or can be awarded them as part of an incentive package.

Any trading profits are then used to make contributions to the EOT which will be used to repay any outstanding purchase monies that are owed to the original shareholders.

A benefit that Halkett singles out are the tax advantages which, in his view, are “often the driving force for the adoption of an employee ownership structure”. But with the growth of ESG (environment, social and governance) themes over recent years Halkett reckons that “the employee voice has only strengthened, and many companies are even more focused on the benefits an employee ownership structure can create”.

And EOT structures are popular. The reason is simple and was laid out by the 2012 Nuttall Review which, he says, “focused on the opportunities that employee ownership could mean for both the exiting shareholder and the employees.” The review promoted the adoption of certain tax reliefs for those choosing to set up EOTs that included capital gains tax relief for the exiting shareholders, and tax-free bonuses for employees. This review led to the legislation that Dempster referred to earlier.

Recent growth

Looking to the 10-year anniversary of Nuttall, Halkett says that momentum in relation to EOTs is gaining pace. He cites HMRC data that was analysed by accountancy firm Price Bailey. It revealed that a total of 312 employee ownership trusts were created in the 12 months ending 31 March 2022 – 78% up on the 181 formed in 2020-2021.

Halkett also points to data from the Employee Ownership Association (EOA), which as of June (2022) reported that there were 1,030 employee-owned business.

In comparison, the association itself says that it recorded less than 500 employee-owned businesses in 2020. It says that many are looking to EO to increase resilience and support productivity in the face of the unprecedented challenges they faced during the pandemic.

The EOA cites the findings of research partners, professors Andrew Robinson at the University of Leeds, and Andrew Pendleton of the University of New South Wales, at the White Rose Centre for Employee Ownership.

Their research found that EO businesses tended to be more socially responsible: 71% had a statement of purpose, which included making a positive contribution to society and the environment, while 96% said that looking after the workforce was a key measure of business success.

Further, they appeared to be more involved and informed with 90% reporting that employees have some or a lot of say in decisions on working conditions, 85% have some or a lot of say in new working methods, and 75% shared financial information at least several times a year.

As Robinson puts it: “Employee ownership is now in the mainstream of British business, thanks mainly to the phenomenal success of the employee ownership trust. These are so attractive because they enable business owners to step back without fear their company will be taken over by someone who does not value the culture, values and employees that are part of the business.”

Employee ownership can be beneficial

Both the EOA and Halkett see benefits for all in employee ownership.

As the EOA has identified, employee ownership offers employees an indirect stake in the company where they’re incentivised through ownership. This in turn leads to greater employee engagement and commitment. It’s a point driven home by the EOA when it says that “employees with a stake and a say in the business are generally more committed to doing what the business needs rather than what they want to do – a behaviour change that benefits the business”.

Chief executive of the EOA, James de le Vingne, says that “a stake, delivered via direct shares, a trust, or a hybrid, along with the accompanying influence exercised through a structure of representation, drives more individual discretional effort”. This, he says, results in “higher levels of financial performance, with new employee-owned businesses reporting an immediate increase in profits in the year after transition”.

And productivity does often increase. The EOA refers to its 2022 index for the Top 50 Employee Owned Businesses by size, compiled by RM2. It showed a median productivity increase of 5.2%, double the UK average of 2.6%. Interestingly, Wolverhampton-based magazine printer William Gibbons & Sons was in 50th place on the list.

 Next come several benefits that Halkett says helps exiting shareholders. They see EOTs as an exit strategy that focuses on the longer-term success of the business; make it easier to obtain a sale (to employees) compared to the open market; can be structured to allow shareholder exits over a longer period or is paid over time; and provide capital gains and inheritance tax reliefs. Notably, establishing an EOT doesn’t require all shareholders to sell their shares, so minority shareholders can remain in place. 

Difficulties with employee ownership

EOT structures requires careful thought and so, the EOA recommends any move to one should be carefully considered over the course of a year or two, or sometimes longer, to ensure that it is the right decision for the business and that it’s moving for the right reasons.

That aside, Halkett talks of the generous tax reliefs he referred to above, but says that for them to apply “the company in question must be a trading entity; holding companies may not be eligible”. (For more on holding companies, see our feature on page 40.)

Also, he says that “employees who benefit under the trust must be treated equally, and any property that vests in the employees must be on the ‘same terms’ – trustees are only able to differentiate between employees based on very narrow parameters such as hours worked, length of service and remuneration”.

But tax limitations (and benefits) aside, Halkett points out that there are also restrictions on the number of employees or directors who can continue to directly hold shares in the company (alongside the EOT) if the entire share capital is not being bought. 

And then, of course, EOTs often need external funding from an institutional lender or from the company itself. This is why some exiting shareholders prefer a more traditional sale route. Further, Dempster warns that with an EOT “it will take time for the original owners to be paid for their shares, often many years – some owners continue to keep large stakes themselves”.

The EOA sees payment to the original owners as coming via a mixture of up-front consideration from existing cash reserves and ‘deferred payments’ funded from future profits. Banks and lenders can also lend to the EOT for the acquisition of shares. However, the association warns that the sale to the EOT must be at market value.

It must also be recognised that not all employees want to own shares. However, Dempster has seen those in managerial positions, who can influence profitability, more motivated to hold shares. She warns that “in some EOT’s there is not a ready market for the shares, and it can be difficult to sell them”.

Making the move

So, where a firm wants to move to employee ownership, exiting shareholders need to discuss the proposal with their financial, tax and legal advisers to assess the structure that is right for them. It’s why Halkett says that “tailored advice is crucial”. As he says: “An EOT will not work for everyone, understanding the process, obligations and timings are important for all parties to understand.”

On the subject of seeking tax advice, the EOA says of Capital Gains Tax relief that an individual or trust disposing of their shares to an EOT, which leads to a controlling interest in the company being held by an EOT, will be exempt from tax on the proceeds of the disposal. Further, there’s an additional incentive in relation to tax-free bonuses: staff at a company controlled by an EOT benefit from an income tax exemption on bonus payments of up to £3,600.

But apart from professional advisers, the EOA considers it just as important to speak, where possible, to others who are going through or have completed similar transactions. It can help members facilitate this.

Dempster also suggests taking informal soundings from businesses that have been effective. She comments that “EOT’s have been successful in all sizes of business – from 20 employees upwards to, say, 1,800 employees”. She says success follows where trading profits are strong as is employee engagement.

But once the transition is made, will adopting an employee-owned structure change the day-to-day running of the company? Halkett thinks not and says that “directors will still need to abide by their legislative duties and take decisions for the success of the company as a whole”.

As the EOA has found, successful employee-owned businesses prioritise their people, and ensure that governance is representative of their employees and their views. Doing this means developing the leadership and management capabilities to recognise employees as owners. 

Understandably, this requires a focus on great communication and engagement, regardless of location or role in the business. Further, management must be prepared to both hear and listen to what employees say. The employee ‘voice’ is extremely important in employee-owned organisations and is normally represented formally, often through the EOT’s trustees.

And on the subject of trustees, the EOA says that they have a duty to ensure that the company is being managed effectively while managing any assets the trust owns. Trust boards are usually made up of employee-elected representatives, an independent trustee, members of the board and, often, the owner or founder.

Now a natural question: can the move to employee ownership be reversed?

In short, yes, and Halkett explains that “a sale to an EOT is the same as a sale to any other shareholder. But to reverse it or change the ownership, a company will need to find a purchaser and undertake an onward sale”.

Of course, this may be back to the original shareholder or otherwise through a standard sale process. The purchase will need funding and will have knock on tax and other implications for both the purchaser and the EOT and potentially for the original selling shareholders. In other words, it may not be viable.

Regardless, Dempster says that the rules of the trust would govern any sale with protection for minorities.

The takeaway

Employee ownership, like any form of entity, has its place. While it offers a great exit for shareholders, they need to think about how they are ultimately to be paid. Similarly, they need to consider also what is best for the company.