ESOP vs EOTs: What is the Difference?

Employee Ownership Trusts (EOTs) and Employee Stock Ownership Plans (ESOPs) are both great ways to retain, motivate and reward staff, whilst also providing a smooth business ownership exit strategy that can be enacted on the owner’s timeline, without the stresses and additional factors of an external buyer. By selling to an EOT or ESOP Trust, your team can directly benefit from your company’s success and feel more directly involved in their place of work. So, what is the difference between them? There are key elements behind how each scheme works that could impact which is the right fit for your company. Keep reading to make an informed choice.

Employee Stock Ownership Plans – what are ESOPs?

An ESOP is a broad term referring to any form of employee reward scheme that enables employees to receive shares in the company. Any company can use this scheme, whatever its size. However, it is notably useful for companies that employees would otherwise be able to purchase shares in. Companies can set their own criteria for allowing employees to participate in their ESOP, but the way they are set up remains largely the same. First, the company sets up an ESOP trust, and the trust then purchases and holds the shares for individual employees. ESOPs have a range of benefits for both companies and their teams. However, there are also downsides, and it may not be a scheme that’s well-suited to every company.

ESOPs: The pros

• Job retention

Owning stock in a company is an effective way to help employees see the long-term benefits in being a part of the team. Your team already receive their salary in exchange for their time and effort, but stock ownership puts a tangible monetary advantage on being a part of the company family rather than moving elsewhere.

• Motivate good work

As well as being incentivised to stay, employees will see a clear and direct benefit to the company’s success. Share values fluctuate depending on a company’s success, meaning your team’s rewards increase if the company is doing well. ESOPs remove the feeling that the company directors are the only ones who benefit from periods of success: this increased sense of ownership, agency and reward should motivate harder, above-and-beyond work.

• Tax benefits

Legal tax benefits are a compelling motivator. For companies, stock contributions are tax deductible, and whilst the ESOP funds are in place, they generate interest for the company. There are tax benefits for the employees, too, who are able to invest pre-tax.

ESOPs: The cons

Employee Stock Ownership Plans have their benefits, but they are far from perfect. As they are based on stock ownership, initial costs and final payouts may vary employee to employee, meaning that some of your team will benefit less from the same scheme than others. This can lead to frustration, jealousy, and even a lost interest or faith in the perks of the scheme.

• Setup and administration

ESOPs require ongoing management. They must comply with various legal and regulatory requirements, including employment law, tax regulations, and corporate governance. This can make the setup process intricate. Administering an ESOP involves tasks such as maintaining records, managing the trust, communicating with staff and enrolling new members, and maintaining compliance.

• Varying prices per share

Share prices change constantly, depending on how a company is currently performing and perceived. As a result, an employee who receives shares at a successful time for the company may receive far fewer shares than an employee who joins the company and receives stock during a slow period.

This variability impacts some companies more than others. If your company has consistent finances, output and turnover month on month, your stocks and share prices will be less changeable. However, if your business is seasonal or you undergo periods of changes, an ESOP may be the wrong choice for you.

• Unstable investment

As well as company performance, other factors can impact share values that are outside of your teams’ control. For example, global factors such as a change of government, wars or pandemics can have a huge impact that can’t be planned for.

This impact could greatly reduce the payout for some employees, if they happen to retire at a time of national financial difficulty – a time when a strong payout would be most welcome. This can also mean that, despite company intentions, some employees barely see a benefit from this well-meant scheme, whereas others will have very different fortunes.

Employee Ownership Trusts – what are EOTs?

An EOT is often used an as exit strategy, though it doesn’t have to be! In this option, a company owner sells some or all of their company shares to a trust, and this trust then pays out to the company’s employees through regular bonuses. Unlike an ESOP, the employees are not assigned individual shares. Instead, the trust will acquire and hold a controlling stake in the company on behalf of all the employees, meaning the team receive a standard and stable form of output.

EOTs: The pros

• Stability

Employees benefit from the trust in the form of bonuses. The appointed trustees can decide when and how much each bonus is, taking into account company performance. However, these pay-outs are on equal terms, not subject to the variability of stocks and shares. Though a company can set their own eligibility criteria, such as length of service, all employees that qualify will benefit the same way, instead of being punished for timing or elements outside of their control.

• Tax benefits

Employees in an EOT receive an income tax-free bonus each financial year. On top of this, company owners who sell their company into an EOT could benefit from a capital gains tax relief on the sale of their shares.

• Motivated employees

By receiving a company performance-related bonus, your team feel a direct involvement with the company and a sense of working towards a bigger goal. Having these stakes in the company both inspires job retention and hard work, as the team know that both the company’s output and longevity will have a direct benefit for them. These motivators are similar to those of ESOPs, but with an added stability of the trust standardising benefits across the team.

EOTs: The cons

• Not all companies are eligible

Not every company can become an EOT. For an EOT to be possible, the company must:

• Be able to sell the EOT a controlling interest (aka, over 50%)
• Have no more than 2/5^ths of its employees individually holding 5% of its issued shareholding
•  Be a trading company or the holding company of a trading group

If you are uncertain whether you are eligible, you can talk to our helpful EOT team.

• Change of control

Following the sale of your business’ majority shares to the EOT, you will no longer own the business in a traditional sense. However, this does not need to be seen as a ‘con’ if approached in the right way: if you wish to retain a guiding voice in the business, this control can still be retained as a trustee. With no new single owner stepping into the picture, your phasing-out of control can be gradual and at your own pace. In particular, many business owners who sell to an EOT choose to maintain an element of control during the deferred consideration period, to ensure your company’s continued strength whilst it completes the payments for the sale. This also allows you time to make sure the company is entering into the next chapter of its life in full strength.

ESOPs vs EOTs: Who wins?

In summary, these two schemes are similar in some ways, and extremely different in others. Both are flexible, both include tax benefits for the company, and both empower and motivate employees with direct involvement in the business’ success.

If you wish to retain the controlling share of your company and have a steady, consistent company performance, then an ESOP could be the way to go. However, where ESOPs can involve variation, inequality, extra consideration from employees and risk, EOTs are stable, easy and fully equal for all team members, with degrees of reward determined by time served rather than the timing of a sale. This, in our opinion, makes them the stronger and fairer options for all companies who are eligible.

Our Solicitors Can Help

Are you interested in exploring an employee ownership trust further? At BHW Solicitors, our team includes experts on EOTs. Get in touch with our helpful EOT team by using the contact form below or calling us on 0116 289 7000.