The sale of The Entertainer to its employees – employee ownership trusts (EOTs)

The founder of one of the UK’s biggest toy shop chains, The Entertainer, is set to hand over ownership of the company to its 1,900 staff, marking the latest in a growing trend which sees business adopting an employee ownership structure. With benefits that include tax exemptions for selling shareholders and employees, minimal disruption to business and employee incentivisation, a sale to an employee ownership trust (EOT) can be an attractive option for all involved. Why is the UK Toy Retailer, The Entertainer, choosing an EOT? Here we will explore the benefits of this model as well as the considerations to bear in mind when deciding whether to adopt such a structure.

How does an employee ownership trust (EOT) work?

An employee ownership trust, or an EOT, is a trust settlement which is set up by an employer company for the benefit of its employees. The trust is operated by trustees who act in the interests of the employees. EOTs are typically set up to acquire the company (in whole or part) from its shareholders. The Entertainer founder, Gary Grant, sold 100% of the shares in the business to the EOT.

There are several statutory requirements which must be met in order for the trust to constitute an EOT and benefit from tax relief, broadly, these include the following:

1.    The trading requirement

The company must be a trading company or the holding company of a trading group.

2.    The all-employee benefit requirement

All eligible employees must be able to benefit from the trust and trust property must be applied on equal terms.

3.    The controlling interest requirement

The trustees of the EOT must hold more than 50% of the ordinary share capital of the company and the associated rights to vote and receive capital.

4.    The limited participation requirement

In the 12-month period before and for the remainder of the tax year after the sale, the following fraction does not exceed two fifths: NP/NE

NP = number of employees or office holders who are ‘participators’ in the company.

NE = number of employees. 

For disposals made to an EOT after 30 October 2024, the following additional requirements apply:

5.    The trustee residence requirement

The trustees of the EOT must be resident in the UK at the time of sale and for the remainder of the tax year in which the sale falls.

6.    The trustee independence requirement

People who fall under the ‘Excluded Participator’ definition cannot have control of the EOT.

7.    The consideration requirement

The purchase price to be paid for the shares in the company must not exceed market value. Any interest on deferred payments to the selling shareholders should not exceed a reasonable commercial rate.

In the context of a sale, the EOT will acquire a controlling interest in the company from the selling shareholders. The purchase price is usually funded using the company’s current capital, with an amount being deferred and paid to the selling shareholders in instalments over the course of a few years out of the company’s profits. Bank funding can also be used to fund part of the acquisition.

What are the advantages of an employee ownership trust (EOT):

• Exit opportunity – selling to employees creates an opportunity for shareholders to exit the business without having to find a purchaser. This is a common option for family-owned business where there is no natural successor. Additionally, an internal sale process is easier to negotiate and tends to run more smoothly.
• Preserving company culture – rather than having an external buyer or private equity house take over, the employees gain control (via the trustees who must act on their behalf) and the management team carry on running the business. There is also scope for the selling shareholders to remain involved. For Gary Grant, who set up The Entertainer in 1981 and ran the business for 44 years with his wife Catherine, preserving the family feel and values of the company (which include its decision not to open on Sundays) was highly important when handing over the baton.
• Employee incentivisation - having a stake in the business, a say in how it is run and receiving bonuses (which can be tax-advantaged) upon its success incentivises existing employees and is beneficial to attracting and retaining talent. Preservation of company culture (as mentioned above) would also benefit staff retention particularly in cases such as The Entertainer, which has nearly 400 staff who have worked there for more than a decade.
• Tax benefits – the selling shareholders and staff can enjoy tax savings as follows:
  • Selling shareholders – no capital gains tax is payable by individual shareholders who sell, together, more than 50% of shares in a qualifying company to an EOT. A claim for relief must be made in the same tax year as the disposal.
  • Employees – during the lifetime of an EOT, employees can benefit from income tax free bonuses of up to £3,600 per year if certain conditions are met.

Key considerations for establishing an EOT:

• Complicated rules around achieving EOT status and subsequent tax benefits – above is a snapshot of the requirements for an EOT but the detail of these must be consistently monitored to ensure compliance and care must be taken not to inadvertently breach the requirements. For example, if the seller were to take security over the shares in the company in respect of the deferred consideration owed to them, this would breach the controlling interest requirement as there must be no arrangements whereby the EOT trustee can lose control without consent.
• Consequence of breaches – if the company fails to meet the requirements within the four tax years after the tax year in which the company is sold to the EOT, any claim for CGT relief is revoked. Any subsequent failure to meet the requirements after this period subjects the trustees of the EOT to a tax charge.
• Conflicting interests – a director of the company may also be a trustee of the EOT thereby simultaneously owing duties to the employees as well as to the company. On top of this, a selling shareholder may also remain on the board of directors. They will owe duties to the company but also have their own interest in ensuring any deferred consideration is paid to them. The differing interests can conflict with one another (i.e. decisions as to whether to reinvest capital into the business, pay employee bonuses or pay outstanding amounts due to the selling shareholders). Having a balanced board which includes non-trustees and trustees will assist in ensuring all interests are taken into account.
• Giving up control – sellers must bear in mind the fact that, at the bare minimum, they will need to transfer a controlling interest in the company to the EOT. Day to day control is typically relinquished on day one (unless the seller remains on the board) but the seller may have a say in strategic business decisions until the time at which they are fully paid. 
• Ensure tax tail is not wagging the commercial dog – it is important that the decision to sell to an EOT is made for legitimate commercial reasons and not purely for tax-saving benefits. Future financial security and longevity of the business needs to be considered.

The numerous benefits to having an employee-owned business explain why many companies (including The Entertainer) have adopted such a model. Care and appropriate advice should be taken, however, to ensure that the complex statutory requirements are met and all involved are able to enjoy the benefits.

How we help

For further detail on employee ownership trusts and how Boyes Turner can assist with these, please see our dedicated page on Employee Ownership Trusts (EOTs) or contact the corporate team directly by email at [email protected].​​​