Jenny gave generously, and lost everything
NB names and details are fictional. Any resemblance to actual persons or events is entirely coincidental!
Background
Jenny truly cared for her employees. She’d started the business, and owned all shares herself. But she knew the staff were as important as her in the company’s success.
She’d always looked after them, and considered them equals. But as she owned the company, the reality was different. They weren’t equal.
Then Jenny read about the EOT, and fell in love with it. She didn’t like her being “the owner”, them being “the workers”. She could change that by transferring 100% of her shares to an EOT.
The business was valued at £1 million. Jenny understood she was expected to sell her shares, and get this amount tax free. But this didn’t sit right with her. She wanted to be no different to the other staff.
So the deal involved Jenny gifting her shares to the EOT for £nil.
The company would then pay her fair market value salary going forwards. That way she’d be no better/worse off than the other staff, an equal. What a great feeling, and a lovely thing to do!
What happened
The staff were delighted! They’d just been gifted a valuable business, and put jointly in charge. They had a lot of respect for Jenny, but were also keen to look after their own best interests.
A few senior staff got together, without Jenny, for a discussion. Their salaries were ok, and the idea to get profit share going forwards appealed. But they also knew the business had significant value.
They approached a business broker. A buyer offered them £1 million (same as it was valued at the time of the EOT transfer), and had cash ready. It was too tempting to resist!
They put this option to the wider team.
Jenny was strongly against it. This was NOT what she had in mind! But her voice was now just one of many.
A majority of the employees liked the idea. They’d each get a life changing one-off cash receipt. There’d be nothing to stop them continuing to work on a decent salary afterwards. Either for the same firm under new ownership, or elsewhere.
The business was sold, and absorbed into the purchasing company. Some staff were kept on. Some staff were made redundant. The business Jenny loved no longer existed.
Most unfairly of all, Jenny was the only person not to get a cash receipt from the sale. She had previously “sold” her shares to the EOT for £nil. Because of that, she was excluded from benefitting from any sale of the shares by the EOT.
Jenny had gone from being in a position of wealth and power, to having nothing.
Indeed less cash than the other staff. She felt betrayed, naïve, and depressed.
What she could have done differently
Instead of gifting the shares then working for a high salary, she could have sold the shares then worked for a low salary.
Yes this would mean she would still be “different” to the other staff, but it gives multiple benefits:
- It could still be generous to staff (as she’d work hard, adding value, for modest salary), but also protect Jenny.
- Even if employees tried to kick her out/sell the business soon after transfer, she’d still be due the business sales proceeds.
- Plus it’s more tax efficient. The salary is taxable for her, the sales value isn’t.
Alternatively, if she was really focussed on being as equal to staff as possible, she could have gifted for £nil but included an “embarrassment clause” in the EOT document.
This means if the EOT sold the shares for more than it paid for them, within a certain timeframe, Jenny would get much of that uplift. This wouldn’t have prevented the onward sale, but would have made it less appealing to the staff.
Moral of the story
By all means be generous, in our view EO works best that way! But do it in a sensible way that:
- protects you,
- is tax efficient, and
- minimises risk to business legacy.
Other Go EO founder flops:
- Greedy Greg
- Vanishing Vanessa
- Controlling Connor
- Premature Pete
- Terrified Terry
- Tracy’s Terrible Trade Sale
Summary
Whilst we’d strongly encourage founders use EO as a way to provide a great deal for staff, there’s good and bad ways to go about it.
- EOTs can be a good equaliser, but isn’t a perfect one.
- Remember you’re giving up control, and might not like choices staff make.
- There are ways you can reduce risk of certain future outcomes.
- The deal can be sweetened for staff in multiple ways.
- Some ways may be more tax efficient than others.
- It’s worth doing some modest “disaster planning” with your advisers.