Various news articles over the last decade have highlighted the number of businesses that have growing cash pools sitting in them. This includes huge corporates like Apple and Google, but also many smaller owner-managed businesses.
Why Are Businesses Cash Pooling?
There are a few reasons why we’re seeing this. A couple of them are:
Reason #1: Lack of Suitable Investment Opportunities.
Generally, you want companies to be optimistic they can make bigger profits by spending cash on business activities, rather than leaving it sitting in a bank account earning trivial interest.
Possibly corporates expect another depression, or possibly there’s simply nothing that exciting out there to invest in.
Whatever the reason, there’s a growing trend to sit on cash rather than borrow/spend and invest.
Reason #2: Relatively Low Corporate Tax Rates vs High-Income Tax Rates.
Perhaps due to the perception of modern, footloose companies emigrating to the lowest tax jurisdiction, major economies have generally reduced corporation tax rates over the last decade or two.
To boost coffers, income tax rates have gone up (as whilst people can emigrate, it’s deemed less likely many would leave all their friends/family to do so just for tax).
Hence businesses get to keep much of the profits they make, whilst owners are reluctant to withdraw much in dividends, keeping their income tax modest.
The result is a growing cash pile. Is this a problem?
Not for the businesses themselves. It gives them safety. Holding cash in a savings account is low risk. However, it can be a problem for the wider economy.
Economies thrive when there are lots of transactions and money is regularly being passed around. This also leads to lots of tax, which is great for governments. Most transactions are taxed in some way.
Large amounts of cash lying in company bank accounts, not doing anything, is considered one reason why economic growth is increasingly sluggish.
Businesses aren’t using that money. They’re not buying more equipment, or employing more staff/paying bigger salaries.
Hence suppliers and individuals don’t have the income they otherwise would. They in turn then don’t spend as much. So businesses they would have bought from suffer. So it goes on.
How EOTs Can Help
EOTs are one way of resolving this, for two main reasons:
- The Short-Term Reason
Founder getting cash out tax efficiently.
Often we see situations where a business owner has allowed cash to build up in the company simply as they don’t want to pay personal tax when extracting it.
If taken out as part of an EOT sale, it’s typically tax-free! The individual can then spend as they see fit, getting that money back into circulation. - The Long-Term Reason
Low/average earning employees won’t be happy seeing the company they collectively control sitting on huge sums of cash doing nothing when they could really benefit from having that cash themselves!
Plus for those with more moderate incomes, the additional tax of receiving the profit share is modest, especially when the first £3,600 per tax year suffers no income tax.
In Summary
Obviously, we’re not suggesting an EOT is suitable for every company, not even every cash-rich company. But it’s one way this cash pooling problem can be solved for some of those businesses. Basically by reducing the temptation to pool it, increasing the temptation to withdraw it.
Not only that, but poorer individuals are more likely to spend a higher proportion of their income than wealthy individuals, who tend to invest/save more.
It’s frustrating that governments can’t see this, and really encourage employee ownership. It helps reduce the wealth divide, as well as reducing cash pooling, both of which will help lead to a thriving economy!
If you are interested in finding out more about transitioning to an EOT, get in touch with us at Go EO to see how we can help.