Insights

September 2013 saw the official launch of the new employee shareholder contracts and we have already written blogs discussing the pros and cons of using these. It is an admirable intention to involve employees as stakeholders in their employing company but what does it actually mean to invite employees to become company shareholders? And what are the implications? For instance, should they be given voting rights? And what happens if they leave the company - do they relinquish their shares? What is the most tax efficient way to offer an employee share scheme?Equally, what do you do if an employee shareholder has outgrown their job or no longer contributes to the company at the right level? Is there a risk that instead of moving on as any other ‘ordinary’ employee would, they stay put because of their shares and the lure of their future gain?

All these issues will be of concern to companies considering awarding shares to employees and entering into new employee shareholder contracts.

A Shareholders’ agreement is essential protection
If you are considering giving shares to employees, a shareholders’ agreement will be essential. It is a private document unlike the company’s Articles of Association and is an agreement entered into by all shareholders which sets out what will happen in a myriad of different circumstances which may occur in the future; it also ensures that all shareholders understand and agree their respective responsibilities and it outlines decision-making processes and procedures to minimise potential conflict in the future.

Importantly for any company considering whether to offer shares to employees, a shareholders’ agreement will protect the company and other director shareholders should relations deteriorate and will set out what happens to an individual’s shares if they leave the company on either good or bad terms.

Although there is an initial cost involved in putting a shareholders’ agreement in place, it is best done at the outset and it is ultimately a cost effective way of protecting the company and all shareholders by providing a clear framework and procedural guidelines. It will also be beneficial if the company is seeking external investment in the future because it demonstrates that a clear risk management strategy is in place should issues with shareholders arise.

Alternatives for awarding shares to employees
It is sensible to have a shareholders’ agreement in place as a first step. Once this is done, it is important to consider the different ways a company is able to offer shares to its employees, and the tax implications.

The new employee shareholder agreements offer a significant tax advantage to the employee shareholder but the value of the shares which can be awarded under these is restricted. If as a result they do not offer sufficient incentive, then an approved Enterprise Management Incentive (EMI) share option scheme, which is an incentive specifically targeted at smaller companies, can be used as an additional or alternative way to offer shares to employees. The EMI scheme offers a number of tax benefits, including certainty of tax liabilities and the deferral of any tax payable until the shares are sold.

Using HMRC approved schemes such as those outlined above will provide tax benefits and certainty which are not available by simply giving shares to employees. A simple gift of shares will mean employees incur unknown levels of income tax at the point of transfer even though they have not received any funds at that time.

Benefit from entrepreneurs’ relief in addition
Two of the criteria which must be met in order to benefit from entrepreneurs’ relief (ER), and hence suffer capital gains tax at the rate of only 10% on a disposal of the shares, are that a shareholder must hold a minimum of 5% of company shares and voting rights and these must be held for a minimum period of 12 months before a disposal.

For shares acquired under an EMI option these criteria are however relaxed; the minimum 5% shareholding requirement is removed and the 12 month holding period commences on the date on which the share option is granted, rather than when the shares are actually acquired. As a result, the acquisition of shares through EMI options is extremely attractive for small minority shareholders.

The Government’s initiative to encourage more companies to reward hardworking employees with shares is a very positive move. This is especially important for smaller companies, which may be unable to offer the large salary and benefits packages of larger companies but want to attract ‘top talent’. The opportunity to ‘co-own’ the company can be a very effective incentive provided that a)the right framework is in place to protect the company against unexpected future issues and b) any gains staff might receive are structured as tax efficiently as possible.

The Government has the bit between its teeth as far as encouraging employee ownership is concerned and is consulting on future incentives to be introduced in the future. As always, we will comment on developments as they occur.

In the meantime, if you are interested in offering your employees shares through an approved share scheme and want to discuss the considerations raised in this article in more detail, please contact Lesley Stalker by emailing las@rjp.co.uk.