What structures are available for employee ownership?

We consider three formal structures available for employee-owned businesses and why these may be suitable.

There are three main structures for an employee-owned company:

1. 100% trust ownership;
2. direct ownership of shares by individual employees; or
3. a hybrid model with a trust holding the majority, and some direct share ownership by specific employees.

The most common form is the 100% owned trust structure, as this is the simplest and cheapest to set up and, if it relates to an existing business where the owners are retiring or setting up their succession plan, has capital gains tax advantages for the outgoing owners.

Trust ownership

In this structure a trust is set up to hold the majority, or all, of the shares in the company.  Usually this an employee ownership trust ("EOT").  The EOT will be created by way of a trust deed which will evidence the creation and also set out the various terms of the trust.   The EOT is a trust with requirements prescribed by legislation.

The trust will then take ownership of the shares by way of a trustee.  In order to enable smooth and simple management for the long term it is usual for the trustee to be a newly incorporated company (limited by guarantee) which will have directors appointed from within the company itself (and often an independent trustee director) who can retire and be replaced from time to time without disrupting the trust’s ownership of the shares.

Careful financial analysis and planning is required to ensure that the  price paid by the trust is financially viable.  The trust itself will have no funds so it will either need to source these by raising third party debt or, as is more usual, the company will make a gift to the trust which will be used to pay the price for the shares (either in full or in part, with the balance deferred and paid out over a number of years from further gifts made by the company to the trust).

The trust deed, together with the articles of association of both the trust company itself, and the underlying employee-owned company, will set out the various terms by which those responsible for running the trust and the company must abide, and what consultation, veto, voting rights etc. they may have.

Whilst trustee directors will almost always come from employees of the company (usually a representative from directors, from employees and an independent) it is important to note that as a trustee the individuals will have certain duties to act in the best interest of the beneficiaries (the employees, on which they may be part) which may occasionally conflict with the duties of the directors of the underlying company.  The governing documentation will set out a conflicts procedure to assist with this.

In an EOT structure there are certain tax benefits which can be obtained where specific statutory conditions are met, one of which being the EOT owning at least 51% of the shares in the operating company.  If these conditions are met then there should be no capital gains tax payable on the sale by the owner to the EOT (though the CGT liability is not extinguished and will instead be caught when/if the EOT decides to sell the shares).  An income tax-free bonus (although do note that NI contributions remain payable) is able to be paid by the operating company to employees in each financial year (as of the writing of this article, this is up to £3,600 per annum) if the EOT holds 51% of its shares.

A trust structure is aimed at long-term employee ownership and a desire by the owners to maintain an existing culture/ethos and local employment.  A purchase by a third party can present difficulties with sharing sensitive information with a competitor (and therefore be a less attractive option).

Direct ownership by individuals

Under this structure the company must decide whether it is going to (i) gift shares to its employees (which will have income tax and national insurance implications depending on the value of the shares), (ii) allow the employees to buy shares for at least market value (so there are no tax implications) or (iii) give employees options to acquire shares in the future (tax liabilities may arise when the shares are actually then acquired).

Each of these routes leads to employees becoming direct owners, and will therefore have the voting and dividend rights attaching to the shares as set out in the company's articles of association.

Tax consequences for the employees can be mitigated if the share ownership is structured itself through a share incentive plan (SIP), a save as you earn options plan (SAYE), a company share option plan (CSOP) or under an enterprise management incentive (EMI).

Care must be taken in structuring the share ownership, with restrictions on the number of shares to be issued and the methods for transfer/sale, so that the company is able to control who become shareholders.  It is therefore common to see in the articles of association provisions requiring the employees to sell their shares internally, and that if they leave employment they must offer the shares up for sale.

The direct ownership route allows employees to be incentivised by the potential capital growth in the value of the shares.

Hybrid structure

In a hybrid structure the trust structure is used but it will not hold 100% of the shares.  There will instead be put in place some individual share ownership to provide for a direct feeling of ownership, some capital growth opportunity or as a more tangible reward structure to incentivise key employees.

As with the direct ownership structure limits should be put in place on the number of shares in direct ownership, and the methods by which these must be transferred.