Employee share ownership: Pros & cons of the different schemes

Share options are a very attractive and simple route to incentivise employees to help grow the value of the business.

Share options aren’t actually shares, but the option to buy shares at today’s price at a future date. A share option is an agreement rather than the share itself.

The benefit to the employee is the potential to invest in a company they already have a vested interest in at a lower price and potentially receive a strong return in the long run.

For the employer, share options can increase loyalty as well as a cooperative spirit as more employees have an interest in the company performing well.

If the employee doesn’t take up the share option then they have no influence and aren’t entitled to accounts or other information – this changes if they do take the option.

Also, it might appear obvious but if an employee leaves and hasn’t taken up any share options then these options are no longer available. However, if an employee leaves once a shareholder, the mechanism for the company to buy back any shares would be outlined in a shareholders’ agreement.

Enterprise Management Incentives (EMIs) are a type of share option with a larger incentive for both employees and employers.

EMIs are only available to certain companies that meet these guidelines:

• Not controlled by another company
• Gross assets of less than £30 million
• Fewer than 250 employees
• The company mustn’t be involved in these activities:

 – dealing in land, commodities, shares, securities or other financial instruments;
– dealing in goods other than ordinary wholesale or retail distribution;
– banking, insurance, hire-purchase or other financial activities;
– leasing (including letting ships on charter or other assets on hire);
– receiving royalties or licence fees;
– providing legal or accountancy services;
– property development;
– farming or market gardening;
– woodlands, forestry activities or timber production;
– shipbuilding, coal and steel production;
– hotels or comparable establishments;
– nursing homes or residential care homes; and
– providing services for another business that would not qualify under any of the preceding exclusions.

• Maximum qualifying options already in issue of £3 million

They are also only available to certain employees who meet the following guidelines:

• Employed by the company or a qualifying subsidiary
• Working at least 25 hours per week, or if less, 75% of total working time
• Not ‘connected’ with the company, doesn’t already hold an interest of 30% or more (including directly, indirectly and existing options)
• Maximum individual holding of options £250,000.

For the employee, provided the price of the share is at least equal to the current market value, then no Income Tax or National Insurance will need to be paid.

Also, Capital Gains Tax is only payable if the individual subsequently makes a gain on sale (however, it’s quite likely that the option holders will be able to take advantage of Business Asset Disposal Relief so the gain will qualify at 10% rather than 20%).

For the employer there are also tax benefits. On exercise, the company gets a tax deduction of the difference between market value at that date and exercise price.

Freezer shares (also known as ‘Growth’ or ‘Flowering’ shares) are essentially a mechanism to secure the founders’ current value and enable minority shareholders to buy-in at a reduced cost and provide an incentive to grow capital value. In other words, they can protect the older generation of shareholders but still motivate the younger generation.

The existing owners benefit from the whole of the current market value of the company, but then split the future increase in value in a different proportion with the new shareholders.

Freezer shares can be used in conjunction with an option scheme to achieve a nominal exercise price in an already valuable company.

For employees freezer and growth shares can be particularly lucrative and low risk. For employers the fact that older and younger generations can benefit can be seen as very inclusive.

Sometimes the simplest, most flexible, and least costly solution is to reward employees through additional salary or a one-off bonus. In order to give your key employees the feeling of participation in the success of the business, the bonus amount could be linked to the profits of the company.

You can consider increasing reward levels for seniority and experience, which can be easily achieved with a bonus structure. Bonus payments can also be used strategically to compliment share ownership and even help fund future share purchases, potentially in combination with an option scheme.

When we support companies in implementing a reward or employee share ownership scheme there are three steps we take.

Design phase

• Together we complete a questionnaire designed to help establish what objectives you and your business are trying to achieve from an incentive scheme
• Old Mill prepares a summary document that outlines what scheme would work best to achieve this.

Implementation phase

• We provide you with a presentation to explain the final scheme (we can even present it to your key people on your behalf)
• We liaise and input the key details with your lawyers who prepare any legal documentation required for implementation
• For certain tax advantaged schemes, we prepare the necessary paperwork and liaise with HMRC.

Ongoing support

• This is often overlooked and is critical for the ongoing success of your incentive scheme. On your behalf, we regularly engage with your employees to ensure the implemented scheme is achieving its desired objectives
• Where required, prepare annual returns to HMRC.

You can find out more about how we can support you to set up an employee share ownership scheme, or if you would like to speak with one of our experts on employee share ownerships schemes then please get in touch with us here.