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Employee ownership models: engaging employees in uncertain times

Posted on 21 July 2016

Employee ownership models: engaging employees in uncertain times

In the recruitment industry, recruiting and retaining a good team can be a challenge. Businesses not only have to contend with the threat of losing good employees to competitors but also to the lure of setting up on their own. Employee incentivisation and engagement, particularly in times of economic uncertainty or change, is a powerful tool that helps promote and consolidate a successful business.

There are many studies which show that businesses with more engaged and proactive employees have significantly higher productivity and greater profitability with a workforce that demonstrates more positivity, commitment and innovation and a higher degree of trust in management. It was also clear during the last financial crisis that those businesses that embraced employee engagement were more robust and resilient through the downturn.

What does employee engagement look like?

Broadly, employee engagement encompasses a combination of involvement and ownership.

In relation to involvement, employees will have a forum through which the strategic goals, development and growth opportunities of the business are communicated to them, and through which employees are able to feed in their ideas, engage with management and have a voice throughout the organisation for reinforcing and challenging views. Some highly engaged organisations will have an employee representative on the management board to ensure the interests of employees as a whole are promoted and aligned.

In terms of ownership, this provides an opportunity for employees to become a stakeholder in the company through a form of share ownership.

Most commonly this is done through implementing an employee share plan which gives employees a direct ownership in the company. Alternatively employees can be given an indirect ownership through an employee trust. Some companies will use a combination of both these methods.

What sort of direct and indirect ownership models are there?

In terms of the direct model, a traditional type of share option or share purchase plan can be adopted. For example:

  • an Enterprise Management Incentive (EMI) Plan: this is the most popular type of share plan for small and medium sized companies as it offers very generous tax breaks under HMRC rules for both the employee and the company. It is an option arrangement that gives the employee the right to acquire shares in the company upon certain events happening, such as achieving specified performance targets, there being a significant new investment into the business or on the sale or listing of the company. However, an EMI Plan is flexible so it can instead be structured to give employees an immediate share ownership, putting them on an even footing with senior managers and other investors. This helps to align interests generally within the organisation and to bind employees into the fabric of the company;
  • a Share Incentive Plan: this is another HMRC recognised plan that allows employees to invest into the business by buying shares on a regular basis. Employees can use up to £1,800 of pre-tax salary each tax year to acquire shares on which they pay no tax at any time (including sale) provided the shares remain within the plan for at least 5 years. In addition, the company can provide employees with free shares up to certain annual limits;
  • growth shares: these are shares acquired by an employee. In order to promote a longer term culture, the shares are subject to certain company performance hurdles being achieved and it is only once the hurdles have been met that the shares are entitled to participate in any capital or income distributions (generally on the same basis as other shareholders). This structure provides an element of cost and/or tax efficiency because the initial value of the shares would be low so that employees can afford to buy into the arrangement. The future growth in value of the shares would then be subject to capital gains tax. Growth shares could be wrapped within an employee shareholder share (ESS) structure which would enable the first £100,000 of growth to be entirely free of capital gains tax. ESS structures need to be considered carefully because of the requirement for the employee to give up certain statutory employment rights;
  • other arrangements: these can include non-tax advantaged share option or purchase plans where a company does not qualify for tax-advantaged arrangements. Whilst there will be no special tax treatment, a company will have the freedom to design a more flexible ownership structure that is suitable for them.

In relation to an indirect ownership model, this would generally encompass a structure through which shares are held collectively on behalf of employees, typically by an employee benefit trust. The trust would manage the shares in the best interests of the employees and could award "points" to employees based on criteria set out in the governing documents. The "points" would represent a proportion of the shares held by the trust and would entitle the employee to his/her share of any distributions the trust receives as the shareholder.

An indirect ownership model may be more appropriate in circumstances where the company has a larger employee population and therefore would prefer not to have lots of individual shareholders or indeed where the company wants to protect itself from a third party takeover.

Whilst a normal trust structure does not qualify for tax benefits, a special "Employee Ownership Trust" (EOT) can be used. This allows tax free cash payments to be made to employees of up to £3,600 each year and enables a business owner to sell his or her shares into the trust tax free. As one of the recently adopted structures by which the Government wants to encourage wider share ownership and engagement within an organisation, a key requirement is that an EOT must have at least a 50% ownership stake in the company.

If you would like to discuss this article in more detail or explore how employee engagement could help your business, please contact Stephen Diosi who heads up the Mishcon Incentives team.

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