A growing number of firms are opting for employee-ownership structures in pursuit of improved productivity, workplace culture, and performance. According to the Employee Ownership Association, as of June 2023 the total number of companies owned partially or fully by their employees in the UK had reached 1,418 – a 37% increase on the number recorded in 2022.
The majority of this growth is driven byemployee ownership trusts (EOTs) – a government initiative, aimed to enable employees to become owners of the business for which they work. EOTs have been recognised under UK tax law since 2014, following their promotion under the 2012 Nuttall Review of Employee Ownership.
To form an EOT, a controlling interest in a company is transferred to an all-employee trust which is then held for the benefit of employees. Owners may retain a minority stake in the business, up to 49%. While the business case for employee ownership may be sound, there are considerations to be had for any firm looking to make the change.
The benefits of Employee Ownership Trusts
Becoming an EOT offers several benefits for both employees and business owners. As such benefits become more recognised within public discourse, the expectation is that the growth of EOTs is set to continue.
- Some of the benefits to becoming an EOT include:
- Boosting engagement and motivation
- Fostering innovative thinking
- Improving productivity
- Making it easier to attract and retain talent
- Regulatory benefits, such as tax-free sale of shares
- Positive reputational benefits
- Business succession
Perhaps the most recognised benefit of an EOT is increased employee engagement. Because employees are direct beneficiaries of a business’ success, such as through profit distributions and other financial rewards, EOTs have been shown to boost morale and motivation of a company’s workforce. By giving employees a decision-making role in a business, EOTs may foster innovative thinking and development.
Each of these bring further advantages, such as heightened productivity, which may in turn translate into improved financial performance. Likewise, by operating as an EOT, firms may be able to stand out from their competition, aiding their ability to attract and retain top talent. Crucially, employee ownership can also have a positive effect on a firm’s public perception and reputation.
There are regulatory benefits, too. Under UK legislation, where shares are sold to an employee-owned trust, businesses may do so free from capital gains tax. EOTs may also offer owners an exit from a business where there is no obvious third-party buyer, or where directors wish to retire while preserving the company's values, legacy, and culture.
For owners of legal practices, EOTs can also provide a succession planning solution that allows for a smooth transition of ownership. They may also serve as an exit strategy for directors who wish to retire while preserving the company's values, legacy, and culture in the long term.
Insurance considerations when becoming an EOT
For firms across all sectors looking to become an EOT, it’s important to have a proper understanding of the process of conversion, including the requirements incumbent upon them, and the potential insurance implications.
In all cases, it’s advised that firms consult with a specialised law firm or accountant to consider the implications of EOT. It’s likely that staff will have questions too, so it’s important to engage with them and ascertain whether a change in status is something that they would embrace.
Key insurance considerations when becoming an EOT include:
- Regulatory – firms are required to change to an alternative business structure (ABS), as well as create the trust itself. These processes will both need regulatory approval, which can take time, and potential further information will be required by the Solicitors Regulation Authority (SRA). Insurers may also wish to understand the reasons why the firm is becoming an EOT.
- Timeframe – the length of time for SRA approval (usually 3 months) is also something that needs careful consideration depending on what time of year a firm’s professional indemnity renewal occurs. Coinciding any transition to an EOT structure with a renewal may save time and effort with insurers.
- Shareholder agreement and company valuation – owners need to agree the terms of the sales of shares as well as getting the company valued to determine the fair value of the shares being sold to the EOT. Any update to a practice’s valuation is likely to be reflected in indemnity insurance premiums.
- Limit of indemnity – if legal practice is an unincorporated business (sole practitioner or partnership) there will be a change in minimum requirements of professional indemnity cover from £2–3m for any one claim. This is likely to have an impact on the premium the firm is required to pay.
- Personal guarantees – there are some professional indemnity insurers who require firms to provide personal guarantees from equity partners/directors. In such cases, firms should speak to their broker to ascertain whether or not this requirement can be removed. The alternative – asking all staff to sign personal guarantees – is likely to be a time-consuming process.
- Employee performance – with staff having more ‘skin in the game’ for employees, heightened commitment to the firm and its success, there is an argument that can be made to professional indemnity insurers that the overall risk profile improves in regard to professional negligence claims.
- Financial performance – converting to an EOT can help to strengthen the financial position of firms. In recent times, insurers have placed increased scrutiny on financial strength of legal practices.
- Succession – as mentioned above, solving the issue of succession is a great advantage of becoming an EOT. Tackling this issue prevents firms from having to either find a suitable acquiring firm or the expensive option of paying for run-off insurance.
For further information, please visit our Lockton for Solicitors page, or contact:
Laura Gray, Vice President
T: +44 (0)20 7933 2705
Dan Blundell, Vice President
T: +44 (0)20 7933 2986
Eliott Lake, Vice President
T: +44 (0)20 7933 2511