Employee shares

Awarding shares for employees is one of our leading specialist areas. We look at implementation, operation and providing an incentive for the employee when the shares are sold. We can work with employers or personally with directors and employees who ask us to review.

Reasons to work with us

What do you want to achieve by awarding shares to employees

Awarding shares to employees is a big step which does require some thought. The type of questions to consider include:

1. Extent of participation

The directors of the employer awarding shares need to decide who do they want to provide the benefit to? Many HMRC approved plans, e.g. EMI, can be granted on a selective basis.

2. How much equity to give away under the employee share incentives?

The choice on how much to give away rests with shareholders.  We prepare share capital tables to show the shareholders the dilution under the share scheme. If employees leave usually they will lose entitlement.  The shares surrendered by former employees can, if that is desired, return to the pool to provide for new awards.

If you are considering gifting over 50% of the business an employee ownership trust has many attractions for both employees and the sellers.

3. What performance conditions, if any, will apply to the employee share incentives?

There is plenty of discretion on this point and no legislative requirements.

4. When will the options convert into shares?

You need to decide what happens on:

• Reaching milestones: for example, years of service, financial targets; etc;
• Sale of the business;
• Demerger or reconstruction of a business stream;
• Voluntary arrangement/administration order.

5. What happens if an employee ceases to be employed?

Should special provision be made for death, injury, disability or redundancy – usually these decisions are left to the directors.

6. Are the employees paying for the share award?

There are no fixed rules. Shares can be gifted for free. Linked into this consideration is should employee enjoy inherent value accumulated pre-award? Another consideration is do you plan for a tax charge for your employees upon the award of shares?

7. How will the shares be sourced for the employee share incentive?

There is a choice of newly issued which dilutes existing shareholders .  Or, to avoid dilution existing shares can be used if shareholders are prepared to allow for a transfer.

For new share issues it is necessary to consider whether the directors have the requisite shareholder approvals to issue shares pursuant to the option/share awards.

If existing shares are being used it is usually necessary to consider the tax position of the transferors. Some companies link equity awards to share buy backs under which existing shares are cancelled.

8. Are the existing articles and/or shareholders agreement adequate?

The articles and shareholders agreement should cater for employee shareholders.  This is because they may present different risks than that of the existing shareholder base.

• For example what will happen if an employee leaves? Do you need good/bad leaver provisions? This is an area where employers often make mistakes which mean ex-employees walk away holding shares.
• The employment contract is quite separate from any contract for equity. This means you can fire as an employee, but unless the articles or shareholders agreement expressly cover the point, the employee or director will remain a shareholder.
• If you are going to force a transfer of shares on cessation of employment – how will the shares be valued? There are plenty of choices ranging from a valuation by the accountants to the ability to appoint an independent expert.
• What valuation method will be used?  Again, choices are available.
• Will employee shareholders be treated the same way as investors and founders? Setting up a new class of shares for employee shareholders is often an answer.

Risks when awarding shares to employees

A badly designed award of shares gives away more equity than intended and does not enhance shareholder value.  You risk demotivating employees and driving them into the arms of competitors, if you fail to meet their expectations.  The directors can expect a backlash from investors.

Potential disaster areas which can be avoided

Known disaster areas surrounding awarding shares to employees can include:

Lack of a share capital dilution table

Lack of a share capital dilution table plotting the fully diluted position if all options and share rights are taken up. The share capital dilution table helps companies to monitor the position and meet the demands of investors.

Poor documentation supporting the award of shares to employees

Common problems arise when the drafting of the terms of the award of shares is not clear.  For example getting the performance criteria and vesting schedule can be tricky and if poorly drafted lead to unintended consequences.

Failing to issue the shares correctly

Employers do sometimes failing to review the articles and shareholders’ agreement to make sure they obtain the requisite shareholder approvals.  Similarly employers can overlook the various requirements under the Companies Act which have to be met when there has been an issue of shares to anyone including employees.

Missing the commercial driver behind the award of shares to employees

If the objectives are unclear it is possible to over look the bigger picture.  The usual end game is what benefit should the employees receive under the award of shares if the business is sold.

Tax on awards of shares for employees

There are various time limits for the reporting and payment of tax on the award of shares to employees.  If the time limits are missed so can the tax benefits be lost.  And, or, a charge to interest and penalties is imposed by HMRC for failure to report and or failure to pay tax on time.