Awarding stock to employees, whether through a formal share plan or otherwise, can be a very powerful tool to reward and incentivise behaviour, playing a key part in the growth and success of a business. Of course, the incentive is only tangible if there is an opportunity to crystallise the value of the shares at some point in the future – normally at the time of an initial public offering (IPO) or trade sale. Equally, early investors will also want a plan so they can realise all or part of their investment.
However, as private companies are currently in the position of being able to raise additional capital from investors more easily without having to IPO, employee shareholders and early investors are being locked in for longer than they had initially expected or wanted. As a result we have seen other solutions being developed through which privately held shares can be traded, primarily through a private secondary market over which the company has little control. Whilst this clearly enables shareholders to realise some of the rewards early, this can have negative effects as far as the company is concerned: an uncertain shareholder base, volatile trading, an unstable share price and in some cases an unwieldy number of shareholders. Employee shareholders also cease to be aligned with the founding shareholders and together this creates a challenge for the company when it does ultimately decide to IPO.
Although in practice the issue has tended to be one faced more by US companies, it is an experience that UK companies should be aware of, learn from and protect themselves accordingly. So what can businesses do?
Firstly a decision should be taken as to whether any trading in the company’s shares should be allowed. Often the answer to this question for private companies is no, in which case sufficient protection should be built into the constitutional documents. For example:
- the articles of association will normally include a transfer restriction that prevents a shareholder from selling his or her shares without the consent of the majority shareholder. Should a shareholder attempt to transfer any shares, the directors can refuse to register the transfer;
- in the context of an employee share plan, a further step could be taken by making it a term of the plan that, should the employee shareholder attempt to transfer any shares, he would automatically forfeit all rights to those shares. They would then become worthless.
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