This is a common, and a really important, matter to consider in any EOT transaction. There is no absolute right and wrong answer to this, but there are some factors which are likely to sway the decision…
- Affordability. The purchase price needs to be funded principally through future profits of the Company. Repayment needs to be balanced against the need to reinvest, grow the business and implement a profit share for the employees. If this all feels too challenging, then retaining shares will naturally reduce the purchase price.
- Continuity. The founder may be identified as the face of the business, particularly where the founder’s name is also above the door. Keeping a connection with the business through a retained shareholding, can send a message of reassurance to customers, suppliers and employees that ‘I’m still here!’.
- Dividends. If shares are retained then the Seller can and should (subject to the success of the business) expect a dividend on those shares. This can provide a Founder a legacy payment long after they retired.
- Sale. Some businesses may be bought out of the EOT at some point in the future. In some industries this may be more likely than in others. Should that eventuality be likely, then retained shares can be sold alongside the EOT shares and the Founder take a subsequent pay-out.
- Leadership. The Founder might wish to hold onto shares which may be transferred to future leaders. This can be tricky to get right and other options to implement this may be better, but retained shares could give the Founder a choice on putting shares into key persons hands.
- Zero CGT. This is only available to the shares transferred to the EOT in the tax year in which it becomes a majority EOT. Once that tax year passes, any shares transfer will be subject to prevailing CGT at the time.
- No Purchase. If shares are retained with a hope that they will be acquired in the future by the Company, the EOT or other purchaser, the Founder must accept a risk that such an eventuality may not come to pass.
- Limited Rights. Minority shareholdings quite obviously cannot control a company’s operation. A Founder might be able to create some limited rights in their favour, but these are extremely curtailed as a consequence of the Controlling Interest Test which restricts a Seller to an EOT from applying a host of veto rights in their favour.
- Fairness. In an employee-owned business where a sense of collective ownership is a desired value, direct shareholdings can detract from this, because despite the message that ‘we are all equal’, some are in fact more equal than others!.
- Strangers. If retained shares are not ultimately acquired by the EOT, consideration must given to the ability to transfer shares. A Founder may wish to be able to freely transfer to family members (and beyond) and this is not unreasonable, but there is a risk of future friction, where there are shareholders who have not had any part in the business operation taking a considerable part of the profits.
In supporting EOTs I have encountered many different approaches and responses to these points. It’s important that sufficient time and reflection is given to this before final decision are made.
If you think an EOT may suit you and your company, please get in touch for initial conversation!
