‘What happens when an employee leaves an EOT owned business? 'is a common question we’re often asked. You may be surprised to hear that you do not need to do anything when an employee leaves a company controlled by an EOT, however, if an employee also has Direct Share Ownership, or if they have an option to acquire shares, then action may be needed.
In this blog, we’ll explore everything you need to know when an employee leaves a company owned by an Employee Ownership Trust, including where they also hold shares directly or have an option to buy shares.
What is an Employee Ownership Trust (EOT)?
EOTs are a type of trust set up to hold all or a majority of the share capital of a business on behalf of its employee. They were introduced in September 2014 as a government initiative designed to encourage employee ownership by enabling owners to sell shares to an Employee Ownership Trust without needing to pay capital gains tax on the sale proceeds.
Learn more about the pros and cons of EOTs in our blog.
How does an employee ownership trust work when an employee leaves a company owned by an EOT?
When an employee leaves an EOT-owned company, it’s quite a simple process. The company’s shares are held in the EOT on behalf of the beneficiaries. The employee is a beneficiary of the EOT. When they leave the company, they are no longer a beneficiary, meaning that they do not have the right to expect anything from the EOT. They are no longer an employee, so they no longer receive any tax free bonuses from the company. There is nothing for either the company or the employee to report to HMRC concerning the EOT.
The only situation where they might still benefit is in the unlikely event of the company being sold and the EOT wound up within two years of the employee leaving when they would take a share of the proceeds as though they were still employed.
Breaking this down further, when an employee is a part of an EOT-owned company:
- The shares are owned by the trustee of the EOT, not directly by the individual employees.
- As the company is owned by the EOT it can make tax-free payments to its employees.
- Employees are beneficiaries of the EOT, meaning that the trustee must use its influence as the major shareholder to ensure the business operates in a way that takes account of the interests of the employees.
- Any benefits are only received while working for the company. When an employee leaves any benefits they receive due to the EOT stop, though if the Company is sold within two years of leaving, the employee may still benefit from that sale.
What happens when an employee leaves with Direct Share Ownership?
Some employee owned businesses may operate with individuals having direct share ownership, meaning that new shares are either sold or issued to certain employees. These are typically put in place to:
- Incentivise employees to stay within the company and help it grow - this is often aimed at senior management.
- Enable employees to have a financial investment in their own company.
The rules regarding what happens when an employee leaves with Direct Share Ownership is usually outlined in the company’s articles of association and/or a shareholders’ agreement. The majority of companies will want leavers to sell their shares back to either the company or another shareholder.
Generally, it’s recommended not to sell shares to an EOT as there are strict rules on what trustees of an EOT can do with their shares. Instead, Employee Benefit Trusts (EBTs) are recommended as they can act as a ‘warehouse’ for buying and storing shares.
The value of the shares paid to the leaver should have been decided upon before those shares were issued and enshrined in the articles and/or shareholders’ agreement, as above. You can choose better values for ‘good leavers’, for example, those who leave due to incapacity or death, or those seen as ‘bad leavers’. These are people who could be leaving due to misconduct or because they’re joining a competitor.
If an employee has an option to acquire shares which have not yet been issued or transferred, the terms of the option agreement will determine what action is needed when they leave. Often the answer is nothing, as the option will automatically lapse on their departure, but this must be checked.
Learn more about how to navigate Employee Ownership Trusts in our blog.
What happens when an employee leaves a Hybrid Model?
A hybrid model is simply a combination of EOT ownership and direct share ownership, so the considerations will be the same as those outlined above.
Employee Ownership Trust’s impact on employee retention
Generally, businesses that have implemented an Employee Ownership Trust and/or Direct Share Ownership, tend to see greater staff retention. Many members of staff will think twice about moving to a different company where employee ownership is involved, as they’ll no longer receive their profit share if they leave as part of an EOT controlled business and may lose the right to a future lucrative equity return if they hold shares directly.
EOTs and employee ownership more widely are a huge incentive for employees and are linked to businesses seeing increased retention, reduced absences and increased productivity. This has ultimately resulted in businesses utilising EOTs and wider employee ownership seeing higher growth trajectories too.
For further information, guidance and support on implementing an Employee Ownership Trust and whether it’s the right choice for your company, get in touch with Gary Davie, who heads our team of Employee Ownership Trust Solicitors today. (garydavie@legalclarity.co.uk)