Employee Ownership Trusts in Divorce Cases
Key points for family lawyers to consider with Employee Ownership Trusts in divorce cases
There are now over 1650 employee-owned businesses and, increasingly, issues around Employee Ownership Trusts (“EOT”) are starting to crop up when we are engaged as Single Joint Expert and Shadow Adviser in matrimonial cases.
In this article we briefly explain the fundamentals of EOTs and where issues may require consideration by family lawyers in divorce settlements.
Essentially, an EOT is a discretionary trust set up to acquire the shares of a company from its existing shareholders. The beneficiaries of the trust should be the employees as a whole (with limited exclusions).
Why do business owners set up an EOT?
Since 2014 - subject to certain restrictions - an EOT allows a business owner to sell a trading company to an EOT and to realise the gain free of capital gains tax (“CGT”). Furthermore, employees can benefit from annual tax-free bonuses of £3,600. EOTs are considered to encourage greater employee engagement.
Typically, the trading company is sold to the EOT which, in turn, has a new company above it which becomes its sole corporate trustee. Additionally, the non-corporate EOT trustees are typically an independent trustee, an employee representative and the vendor.
The purpose of this article is not to discuss the pros and cons of EOTs but to outline the issues that may arise in a divorce settlement.
EOTs and divorce settlements
Deferred consideration
Typically, when a business owner sells his or her company to an EOT, only part of the consideration will be in immediate cash. The balance is likely to be deferred consideration (which can be substantial) and may amount to, say, 50% to 75% of the value of the business. The deferred consideration is an asset of the vendors of the business but is not normally shown as a liability of the trading company. Although it is a liability of the EOT, it can only be repaid from the profits of the trading company. So, in the context of a divorce, the question arises as to the value of that deferred consideration.
Often the terms of the transaction assume the deferred consideration is repaid over several years, perhaps as many as five or more years. This repayment period is considerably longer than might be expected in a trade sale. Over this period, the fortunes of the business may decline and it may not be able to repay the deferred consideration in full. An assessment will be needed of the risk that the monies may not be repaid and the time value of the deferred receipts.
EOT valuations
In considering the value of the business at a point in time, any valuation that was undertaken for the EOT may be relevant. Recent changes to EOT legislation mean that the EOT trustees must obtain an independent valuation. However, this valuation is intended to ensure that the business is not overvalued rather than undervalued. Furthermore, the vendor and advisers may be comfortable with a lower valuation for various reasons including the availability of finance, the beneficial EOT tax regime and because the EOT is intended to benefit the employees.
Impact on maintainable earnings
Whilst the vendors may remain employed in the business after an EOT is implemented, the ownership has changed and the owner’s remuneration is likely to be impacted.
In summary
EOTs are becoming increasingly popular because of the nil rate of CGT applied to the disposal proceeds. We are now seeing EOTs crop up in family matters and an understanding of the legal structure and implications for value is essential.
My final point for any shareholders (including family companies) considering a disposal to an EOT is to get independent financial advice from an adviser who will not be involved in the transaction. In my experience, business owners may be attracted by the tax advantages and fail to understand the full implications and potential problems.
Getting in Touch
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Email: fiona@fhmforensic.co.uk
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