The pros and cons of involving employees in business succession planning

Business succession planning is the process of preparing for the transfer of ownership and management of a company to new owners or leaders. It can be triggered by various events, such as retirement, illness, death, or perhaps simply just a strategic decision to sell the business. Succession planning is crucial for ensuring the continuity and sustainability of the business, as well as its value and legacy. Luke Morris, Corporate Finance Partner explores the pros and cons when thinking about involving employees in business succession planning.

It’s a big deal for the business owner. But it’s perhaps an even bigger deal for those people who are at the coal-face everyday, with mortgages or rent to pay and families to provide for. Lots is written about “employee engagement” in day-to-day business. But what about employee engagement in a business succession process?

One option is to involve employees directly, either by selling the business to them or by giving them a stake in the ownership and decision-making. This can be done through various mechanisms, such as employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), cooperatives, or partnerships.

Why would an exiting business owner look to do this?

• Employee involvement can provide a smooth and quick transition of the business, as the employees already know the operations, the customers, and the culture of the company.
• Employee involvement can preserve the mission and vision of the business, as well as its social and environmental values, by avoiding selling to external buyers who may have different agendas or priorities.
• Employee involvement can increase the motivation, engagement, and loyalty of the staff, as they feel more valued and empowered by having a stake in the business. This can lead to higher productivity, innovation, and customer satisfaction, as well as lower turnover and absenteeism.
• Employee involvement can also create a positive impact on the local community and the wider society, as employee-owned businesses tend to be more democratic, accountable, and responsible. They also tend to invest more in training, development, and social causes, and pay more taxes than conventional businesses.
• Employee involvement can offer tax advantages for the current owners, as they may be able to defer or completely nullify their capital gains tax liability.

However, there are also some challenges and drawbacks of involving employees in business succession planning, which need to be carefully considered and addressed. Some of these challenges are:

• Employee involvement can require a significant amount of time, effort, and resources to set up and implement, as it involves legal, financial, and organisational complexities. The current owners and the employees need to agree on the valuation, structure, and governance of the deal, as well as the financing and repayment options.
• Employee involvement can also entail a cultural and behavioural shift for both the current owners and the employees, as they need to adapt to new roles and responsibilities. The current owners need to relinquish control and trust the employees to run the business, while the employees need to develop new skills and competencies to become owners and managers.
• Employee involvement can pose some risks and uncertainties for the future of the business, as it depends on the performance and commitment of the employees. If the employees are not prepared, motivated, or capable of owning and leading the business, it may affect its profitability, growth, and resilience. There may also be conflicts or disagreements among the employees over the strategy, direction, or distribution of the profits of the business.

Involving employees in business succession planning can be a viable and beneficial option for both the current owners and the employees, as well as for the business itself and its stakeholders. However, it is not a simple or straightforward process, and it requires careful planning, preparation, and communication to ensure its success. Therefore, it’s important to take appropriate advice, especially if you’ve heard about EOTs from a friend down the pub and are thinking that it may be the way forward.

EOTs were first introduced in 2015 and whilst it has taken some time for them to gain in popularity the EOA (Employee Ownership Association) says that the number of EOT transactions went up by 37% in the year to June 2023. This means that there are now more than 1,400 businesses in the UK that are owned by an EOT.

The gain in popularity has inevitably attracted the attention of policymakers. One concern is about the governance of EOTs. Ministers are worried that some business owners are trying to keep significant control of the company after the sale, appointing themselves as trustees on the EOT board, as well as on the board of the business itself. The government has proposed rules to stop this with legislation that limits the seller and its representatives to having only a minority of trustees on the EOT board possible to likely follow.

Another concern is about the generous tax benefit that EOTs offer owners. The sale of a business usually triggers capital gains tax (CGT) on the proceeds – normally at 20%, although with a 10% rate on the first £1m of gains due to business asset disposal relief (BADR). However, owners who sell to an EOT pay no capital gains tax at all. Instead, the trust established takes on the tax liability, which then pays CGT on any secondary sale. And secondary sales have been vanishingly rare so far. EOTs set up abroad can in some circumstances avoid this CGT liability, potentially allowing business owners to pursue a second sale but to dodge CGT completely. So we expect legislation on this too.

Practice is developing, so if you have considered the benefits of employee ownership and think that an EOT may be the way forward, speak with us first! To get in touch, please call Luke on 0330 058 6559 or emailing hello@scruttonbland.co.uk