It is well established that many companies have arrangements in place to enable their employees to buy or receive shares in the company. This may be done for a variety of reasons, including:
- to align the interests of employees more closely with shareholders;
- to incentivise employees to achieve defined business and/or individual performance targets;
- to reward past performance;
- to remunerate employees in a more tax efficient way; and
- in the case of private companies, encourage employees to work towards an exit, such as an IPO or trade sale.
Typically shareholders have been willing to set aside around 10% of share capital for their employees, with a variety of structures being used through certain types of option or share purchase plans.
The financial crash of 2008/09 brought much debate around whether businesses were too focused on achieving short term financial goals and simply looking to create opportunities to sell the business for profit, rather than investing in its long term future. Criticism was also made against more traditional forms of employee incentive arrangements, the performance objectives of which were perceived to encourage short termism, particularly in the financial services sector, where significant legislative reforms have since been made.
And therefore emerging from this, we have started to see a cultural shift in the mindset of many business leaders and owners around how employees can, and perhaps should, play a more significant part in influencing the successful outcome of businesses. This has given rise to the employee ownership model.
What is the Employee Ownership model and what’s the benefit?
The employee ownership model is not an altogether new concept. The John Lewis Partnership is often lauded as the prime example, in which every employee has a share in the company. Of course, to be an employee owned company, it is not necessary for the company to be 100% owned by its workforce, but there will usually be a significant part of the share capital that is reserved for them, backed by a governance system that gives the employees an oversight of and the ability to influence management decisions through a number of democratic bodies.
Research has shown that employee owned businesses tend to achieve higher productivity, a greater level of innovation and are very profitable and more resilient to economic change. This is not surprising given the engagement of employees in the business which promotes long term behaviour and alignment of interests.
The employee ownership model can also be a useful solution for business succession where a trade sale or management buy-out may not be the preferred route. Selling the business to employees enables an owner to realise the true value of the business whilst ensuring that the company continues to be run by those who share the values of the owner and who have a vested interest in it. In addition, an employee buy-out can be structured in a very tax efficient manner, particularly given the introduction of a complete capital gains tax exemption where shares are sold into a specific type of employee ownership trust.
How can employee ownership be structured?
Employees can be given a direct or indirect share ownership or a hybrid of the two. Companies need to think carefully about what best suits their culture and objectives.
Direct ownership will give employees a greater sense of immediate ownership and entitle them to share in ongoing capital growth. Under this model, employees can:
- Be given shares for free;
- Buy shares; or
- Be granted an option to acquire shares in the future.
Being given shares for free would generally attract an upfront income tax and NICs charge, although it is possible to structure the arrangements through a tax advantaged plan, such as an Enterprise Management Incentive Plan, a Share Incentive Plan, a Save As You Earn arrangement or a Company Share Option Plan.
Consideration needs to be given as to how employees will fund a share purchase and how value from their shareholding would be crystallised, for example it may be necessary to operate an internal market. In the case of leavers, a decision will also need to be made as to whether the employee shares would be forfeited or retained in certain circumstances.
Indirect ownership might be more appropriate for companies that want to create a culture of longer term or permanent employee ownership or to protect itself from a takeover. It is likely to also be preferred as a succession solution.
Indirect ownership would involve creating an employee trust. The trust would hold all of the employee shares and employees would be rewarded through an annual profit share. Since 6 April 2014, the trust can be structured to provide a complete exemption from capital gains when selling shares into it and can be used to provide income tax free bonuses to employees of up £3,600 per tax year. The trustees would typically comprise of directors of the company together with an employee representative and an independent director (such as a professional adviser). A trust deed would set out what the trust can (or cannot) do with the shares and how distributions will be made.
A hybrid ownership will generally involve the trust retaining a minimum percentage of employee shares, together with a distribution of shares to employees through a share purchase or option arrangement. This may be appropriate for companies that prefer trust ownership but wants to provide some degree of shorter term capital growth and a direct feeling of ownership.
What’s the future for the employee ownership model?
According to figures obtained by the Employee Ownership Association (EOA), the employee ownership model is the fastest growing form of business ownership in the UK and currently delivers 4% of UK GDP annually. The EOA has set a target of increasing that to 10% of GDP by 2020.
Having been on the Government’s agenda, useful tax reforms were introduced in 2014 to help make the employee ownership model an attractive proposition for both companies and employees. Suitably flexible, it can be implemented by both start-up and established businesses and can be a viable solution for business succession.
To discuss employee ownership in further detail or any aspect of employee share incentive arrangements, please contact Stephen Diosi at firstname.lastname@example.org or on 0203 321 7534.