Could a hybrid approach make the employee ownership model fairer?

Since the UK Government introduced new legislation in 2014 to make selling to an employee ownership trust (EOT) more attractive, one of the criticisms levelled at EOTs is that they benefit the selling shareholders more than the employees.

It is now well-known that if certain conditions are met, then the sale of a company to an EOT can be exempt from capital gains tax, which can be a huge saving to the selling shareholders. On the other hand, the tax benefits for employees can be rather modest. The current rules permit employee-owned companies to pay up to £3,600 annually to each of its eligible employees as a tax-free bonus, a figure which has not increased since the new legislation was introduced ten years ago. It must be said that focusing solely on the tax benefits available to selling shareholders and eligible employees under the current regime completely disregards the wider benefits of employee ownership.

It has been frequently demonstrated that employee-owned businesses can increase employee productivity due to greater personal investment in the success of the company, help with staff recruitment and retention, keep jobs in the local area and preserve the company’s culture and values. However, it would be wrong to disregard the genuine concerns of some employee-owned businesses around how they can better incentivise their employees in an increasingly competitive job market. One option may be to consider a hybrid employee ownership model.

When the shares in a company are held by an EOT, this represents indirect employee ownership: the EOT holds the shares for the benefit of the company’s employees but the employees do not acquire shares individually. On the other hand, direct employee ownership is where the shares in the company are held in the individual names of the employees. While this can offer tangible benefits to the employee-shareholders, such as the ability to vote on resolutions and participate in dividends, it can be impractical and present a number of administrative challenges as employees come and go.

However, indirect ownership and direct ownership need not be mutually exclusive and a hybrid employee ownership model could offer a more balanced approach.

In addition to the other qualifying conditions, the current legislation provides that the EOT must hold a controlling interest of more than 50% in the company for the capital gains tax relief to apply for the selling shareholders and for the company to qualify for the tax-free bonus payable to eligible employees. This opens the door to a smaller interest being offered directly to employees, giving them a personal stake in the business and potentially the opportunity to participate in dividends or the growth of the company if they ultimately sell their shares at a profit in the future.

We have certainly seen an increasing number of employee-owned businesses considering Enterprise Management Incentive (EMI) share options, Share Incentive Plans (SIPs) or other non-tax advantaged plans as appropriate. Usually these schemes are focused on key employees who are seen as crucial to the performance and growth of the company.

This can lead some to argue that the existence of share options and share incentive plans are incompatible with the principle that employee ownership must be for the benefit of all of the employees on the same terms. Accordingly it is vital that the terms of any direct ownership are carefully considered, by the company and the EOT, to avoid creating problems in the future.

One of the key benefits of a hybrid employee ownership model is its flexibility. Each employee-owned business will have its own particular requirements and, with advice and careful planning, the hybrid model can be implemented in a way that addresses these priorities and provides meaningful benefits to employees alongside the majority control exercised by the EOT.

Authors: Douglas Roberts and Nimarta Cheema

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2024. Specific advice should be sought for specific cases. For more information see our terms & conditions.