One of the most often used and valuable of the Capital Gains Tax (CGT) exemptions is...
Retaining key staff should be high on the list of priorities for any employer, so providing a good package of benefits is crucial. There are many ways to do this, including awarding shares for employees.
If you decide to go down this route there are lots of aspects to consider including the criteria for awarding the shares, and the terms that will apply.
Our guide considers the various options for awarding shares to employees.
Consider Eligibility Criteria
It is a big decision to award shares to employees and there needs to be absolute transparency around who is eligible and why. Some of the questions you could consider to help you reach a decision include:
Level of participation
You do not have to offer shares universally but you need to be clear about who they will be provided to and on what basis. You could choose to offer shares to all employees at a certain level, or you could attach performance conditions to them.
There are no legislative rules about what you can or should do, so it is possible to make your own decisions. There are HMRC tax-advantaged plans such as EMI share schemes that offer flexibility while still being very efficient.
Once you have determined the criteria for share eligibility you can calculate the amount of equity that can be given away. Your shareholders will need to provide some input into this decision and it is a good idea to put together an example of the dilution that will occur.
It is common for employees to lose their entitlement if they leave the business; this can be a useful mechanism to boost the pool for further share distribution amongst loyal employees, preventing additional dilution to external ex-employees.
If you anticipate that more than 50% of the business will be given away, an EOT (Employee Ownership Trust) may be the best option.
Despite your best efforts to retain employees, some may still leave which raises the issue of the share status on exit. You can choose how you want to manage this but it needs to be clearly set out in the terms. You can include special provisions for certain circumstances which may be exceptional, such as disability, death or redundancy, but you are not obliged to do so.
When an employee leaves you have the choice of either allowing them to keep their shares/options, or you can stipulate that they must be sold back to the company. If the latter applies, you will need to have terms which explicitly state the price that will be used for the buyback. Shares which are bought back by the company can either be cancelled or held in Treasury and recycled for distribution at a future date.
Options or shares?
As part of the process you will need to set out when the options convert into shares, and what will happen if certain events occur. The types of events to consider include the sale of the business, IVA (or similar) and demerger or business stream deconstruction. You might also want to think about whether any milestones will be recognised such as a set numbers of years’ service.
How to Source Shares
There are three separate ways to source the shares for distribution to employees. These are: transfer of existing shares, using Treasury shares the company has bought back or newly issued shares.
Transferring existing shares will require the permission of the shareholders. They will also need to agree if fresh shares are to be issued because this will dilute the value of theirs. If the company has purchased shares from employees who have left, these can be easily used for redistribution.
The shareholders agreement may need to be changed if it is not suitable for the provision of issuing shares to employees. There are different risks which may present themselves and it is important that a shareholders’ agreement covers all eventualities.
The shareholder agreement should include the following:
- The process for when an employee leaves
- How shares will be valued on any transfer/cessation of employment
- The method of valuation
- Class of shareholders - do you want employees to have the same shareholder rights as investors and business owners? Many companies opt to include employees in a separate shareholder class
The shareholders agreement is separate and distinct from the contract of employment. If you do not want ex-employees to be able to continue to hold shares after they have left, this will need to be explicitly set out in the shareholder agreement.
Awarding shares to employees is a complicated area and mistakes are often made if the process is not robust and well-considered.
Some of the most common errors include:
Not creating a share capital dilution table
It is easy to lose track of the impact of shares, and it can lead to dissatisfaction among investors if you are not clear about the effect of new shares on value. A capital dilution table which allows the impact to be easily calculated and tracked is an essential tool to ensure the value stays within agreed boundaries.
Poorly worded eligibility terms
Deciding on the right criteria and how this will be assessed is vital for the awarding of shares to be viewed positively, rather than causing resentment. There must be full clarity in the terms and for everyone to understand how the clause is triggered.
Slack financial management
Although there are many tax-efficient share schemes they must still be properly reported to HMRC to retain their advantages. Failing to meet your obligations for either reporting or paying tax on the shares could result in the loss of the tax efficiencies.
Incorrect issuing of shares
As well as gaining the proper shareholder approval for the issuing of any shares, a business must also consider the requirements set out under the Companies Act. Failing to meet obligations under either of these points can cause shares to be issued incorrectly.
Risk and Rewards
Done properly, issuing shares to employees can be a very positive reward and be an attractive part of the overall remuneration package. However, if the scheme is not properly thought-out then the expectations of employees may not be met, and shareholders may become disgruntled with a loss of shareholder value.
For these reasons, it is imperative to take professional advice when awarding shares to employees to ensure that all parties receive the optimum benefits possible.