Craig Simpson, Tax Partner at Bates Weston considers whether used in tandem an EOT and an EMI are a perfect marriage?

Employee Ownership Trusts (“EOT”) continue to grow in popularity. This is perhaps not surprising given the generous tax relief available to the shareholders. A great example of the tax system being used to encourage and drive a particular behaviour.

EOTs are at their most popular when a trade sale is not available and there is no obvious second tier management team to undertake a Management Buyout. The EOT is structured to allow a phased exit of the shareholder/director team often funded by cash upfront and fixed deferred payments.

In order to secure the future of the business, second tier management will emerge and one of the challenges of the EOT structure is how to motivate those new key individuals in the longer term. There is a risk that without some sort of incentive alongside the EOT then the drive of incoming management may be lost and the whole purpose of employee ownership into the longer term may well be lost.

How can this problem be solved? One route is the use of Enterprise Management Incentive (“EMI”) share options alongside the EOT. This would work by granting share options to key individuals with the ability to acquire shares in the future based on predetermined conditions and price set out in the option agreement.

The option exercise condition could be set to the time when the former shareholders deferred consideration has been paid off by the EOT trustees. This a natural progression to brings the new management team into share ownership. For example, say there are three members of the management team who are granted EMI share options over 10% each of the share capital of the company (30% in total). On exercise they would acquire new shares in the company, effectively diluting the EOT trustees to 70%.

Provided the EOT trustees do not drop below 51% ownership of the company then this would work to maintain the EOT qualifying conditions.

The result is a management team with direct equity ownership but with a majority of the business still owned by the general employee group. Should the company be sold in the future the management team receive 10% of the proceeds each directly and 70% is paid into the EOT to be paid out to employees under the equality basis required by the legislation.

Overall, this could be a powerful combination.

We have significant amount of practical and technical experience in implementing EOTs and EMI share option plans. Please contact Craig Simpson or Richard Coombs if you would like to discuss how we can help you.

As always, you are reminded that this article is generic in nature and you should take no action based upon it without consulting your professional advisor.