A question we get asked often is:
“Should I retain a minority shareholding, and if so, how much?”
There’s of course no correct answer to this, or universally agreed recommendation. It comes down to personal choice.
Background
To get the tax perks of an Employee Ownership Trust (both CGT for seller & profit share for staff), the EOT needs to own a controlling stake. I.E. 51+%.
There is no requirement for it to own 100%. So there’s 49% worth of minority shareholding to potentially be owned by others.
For this blog post, we’ll assume the most common, simple pre sale situation applies. That the founder owns 100%, no previous quirky investments received.
Should founders sell 51%, 100%, or somewhere in between?
We discuss key things to bear in mind when deciding whether to retain a minority shareholding.
Future staff resentment
Say you sell 51% to the EOT, retaining 49%.
First few years, business does well, everyone’s happy. The spoils are now shared. Yes you get the lion’s share, but:
– you used to get it all,
– staff know and like you, plus
– they appreciate what you’ve done.
Press forward 10 years. New recruits don’t know who you are. Yet 49% of profits they generate go to you. This can cause friction.
Possibly you’re thinking why should you care?
Disappearing profits
Take the above situation, where you’ve sold 51%, retained 49%. Years after sale, you’re living in the Bahamas, and the business is making lots of money. Great, right?
The team stuck doing all the work can either:
– get 51% of profits with a modest tax break, or
– give payrises/bonuses to wipe out profits.
The latter means no tax breaks, but 100% of profit for them.
If they resent you, risk is you get 49% of £nil, which ain’t a lot!
The EOT will own the majority of the company’s shares. This means it controls the company.
Minority shareholdings have negligible power. You’ll likely also be restricted in who you can sell them to.
Combined, these mean retained shares have limited value.
A 20% shareholding in a small private company tends to be worth much less than 20% of the whole.
Cashflow/Affordability
Unsurprisingly, buying 100% of a business costs more than buying 51% of the same business.
Hence a benefit of retaining shares, is the initial sale price is lower. In turn the company should be able to pay it off in full (IE reach “financial freedom day”) more quickly.
Like clearing the mortgage on your home, when EO companies clear any founder debt, it’s a great feeling! Plus if nothing else, it tends to mean more profits now available to pay out to staff!
Capital Gains Tax
You only get the CGT free sale in the tax year the EOT gets a controlling stake.
So if you sell 100% now, great, the whole lot is CGT free (subject to you meeting the other criteria of course).
If on the other hand you sell (say) 60% to the EOT now, thinking you’ll sell the remaining 40% in 5 years time, the future 40% sale will be taxable. This applies even if that further sale is also to the EOT.
One slight exception/clarification of this, is it’s any sales to the EOT in the tax year the EOT gains control that are tax free. So hypothetically you could sell 60% in May, 40% in December that same year, and both sales would be tax free.
Future options
Retaining shares gives you choices what to do with them later.
Say you put two people in charge of the business following sale. One works nicely with you, the other tries to screw you over.
You’ll likely be able to sell, at a friendly rate, your shares to the person who was nice to you.
May sound twee, but important for some.
Future headaches
The flip side, you’ll need to do something with those shares at some point.
The EOT sale likely involved a lot of decision making, what’s right to do etc.
Are you just leaving yourself an awkward decision for further down the line?
A 100% sale gives a clean break.
Sentimental reasons
Sometimes people keep (say) 5% for sentimental reasons. A little toehold.
Yes, there may be modest long term income, and/or mini windfall at future sale event, but that’s not the motivation.
Unlike the 49% situation above, few staff will resent 5% of profits going to a historically critical individual.
Simplicity
100% EOT owned is easier. Professional fees may be slightly lower.
There’s no mixed motivations. No “us and them”.
You can just have one share class.
This can all be appealing, but…
Are staff all equal?
Inevitably there are those who push things forward, work overtime when needed, innovate. They help the business survive in tough times, thrive in good times.
There will also be people who turn up, do their basic job, and go home.
Both are fine…but businesses need some of the former. Should those people have greater incentive via direct ownership?
Some would say yes. Shares outside the trust gives scope for this.
Summary
Going from owning 100% of a company to owning 0% of a company is a huge deal. It may superficially seem a nice half way house to retain a decent stake.
But as the EOT needs to own a controlling stake, selling is a huge deal even if you retain 49%. You’ve given up control.
If you want to retain a minority shareholding, challenge yourself as to why. Remember the value can go down as well as up. It won’t give you much power. Think about how both you and staff will feel about it in 10 years time.
There’s no right or wrong answer, and of course a benefit of only selling some now is you have flexibility to sell more later. If you sell 100% now, there’s no going back.
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.