When building a business from scratch, you craft every detail, from its values to legacy and brand name. Your business becomes your identity. To ensure your business sustains the legacy after you, you must create a succession plan to smoothly transfer the company’s ownership to those who can carry out the business in the same spirit. As a business owner, you have options like selling it to a competitor or third party (hedge fund), passing it on to your family, or dissolving the business. Now, you can transfer ownership to employees through Employee Ownership Trusts (EOT), thereby preserving the values and relationships and enhancing long-term sustainability.
What is an Employee Ownership Trust (EOT)?
The concept of EOT revolves around giving the business ownership to employees by creating a trust where employees are the beneficiaries. EOT operates as a trust that files annual trust returns and maintains detailed records of its activities, including acquiring and distributing shares. The business owner sells the controlling stake in the company to the trust, and the trust buys it using the reserve it has built from the company’s profits, external financing, or employees chipping in their money.
Note: The contributions made to the EOT reserve can be deducted from the taxable income.
Business owners can gradually transfer the stake to the trust, reducing the stress of arranging a large amount or taking a loan. The EOT uses the business profits to buy your ownership stake over time, and you benefit from regular cash flow. However, this method could be risky if the business runs into losses and shuts down.
Unlike other trusts, which are deemed to be disposed of after 21 years, with all their assets sold and capital gains realized, EOT can continue to operate even after 21 years.
The trust structure aligns employees’ interests with the company’s long-term success. When employees know they can be the owners and get a share in business profits, they will strive to sustain and grow the business. However, the success of EOT depends on the incentive structure, which should encourage employee participation.
Should You Consider Employee Ownership Trust for Succession Planning?
Now that you have a basic understanding of EOT, does it fit into your succession planning? To answer this question, you have to visualize your future financial needs and the needs of your business and get clarity around them.
Succession options have their challenges. Transferring ownership to the family can lead to family disputes and harm personal relations. Also, the family may not be interested in running the business. Finding the right buyer may be a challenge if you want to sell your business. EOT offers a viable option for succession. However, your business should also be suitable for sustained under employee ownership.
When considering EOT as a succession option, ask yourself the below questions.
Is Your Business Financially Viable?
EOT might not be a good option if your business is fraught with challenges that question its sustainability. Only a company with a strong business plan, clear growth strategy, and positive cash flow that can sustain under employee ownership can make EOT a viable option. The financial viability is also a requirement of the Income Tax Act for consideration of a qualifying EOT.
You could probably start working around the business growth strategy and financial planning. No business is without hiccups, but these hiccups strengthen the business model. Succession is a long-term plan; you can tweak your approach when you have your goal.
Do You Want to Preserve Legacy and Values?
For many business owners, the business goes beyond providing an income source and focuses on preserving the legacy and family values. Hence, many family-owned businesses consider hiring a successor from within the family. Since they have employees working closely with the family, employees can continue working towards the company’s mission and vision even after a change in ownership.
If the family has no successors, the business owner can consider transferring the ownership to employees.
Do You Want Business to Continue with Minimum Disruption?
They often integrate their process when you sell your business to a third party. The transition to a new owner could disrupt the business operations and bring uncertainty around business sustainability. Small companies that mainly cater to local residents and work towards a community’s economic development might want to retain ownership with the employees who have built a strong relationship with the community.
If you envision growing your business with minimum disruption, transferring the ownership to a family member or employee is a viable option.
Do You Want Business Transition to Be Flexible?
Succession planning could have several hiccups, and your financial needs at that time might also change. If you do not want to give up complete control of the business in one go and want a gradual handover, EOT might be a viable option.
While you still have to sell a controlling stake to the EOT and let employees vote on major decisions, you can remain involved in an advisory capacity until the trust assumes control. As we discussed before, the EOT can keep buying stakes from the business owner with future business profits. This could assure you that the business can grow even in your absence.
The EOT could be a viable succession plan for a successful business with dedicated employees. However, a qualifying EOT has to meet some specific requirements laid down by the Income Tax Act or risk getting disqualified. A professional estate planner can help you navigate the various requirements and complex laws to ensure smooth and compliant succession.
Contact Edelkoort Smethurst CPAs LLP in Burlington to Help You with Succession Planning
A skilled estate planner can help you explore various succession options and implement them in an organized and tax-efficient manner. At Edelkoort Smethurst CPAs LLP, our tax experts and estate planner can provide services to prepare an employee ownership trust, revisit the business model and design a lucrative incentive structure. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with expertise, contact us online or by telephone at 905-517-2297.