We’ve been asked to advise upon and have implemented some employee shareholder arrangements in the first few weeks of their existence. As the employee shareholder concept has been criticised by many in HR and employment law, we have set out our experiences to date.
To recap, employee shareholder arrangements became permitted with effect from 1 September 2013. The principle is that individuals give up certain statutory employment protections if they receive at least £2,000 worth of shares in return. The capital gains on the shares will not attract tax on up to the first £50,000 and the first £2,000 worth of shares are received free of income tax and NICs.
What we’ve learned so far is set out below.
1. It’s all about the tax
The driver for implementing all of the arrangements we have put in place or advised upon has been tax saving for the employee on the shares. It has been aimed, so far, at easing the tax burden on employees who would in any event be offered an equity stake. Think private equity, venture capital backed startups, carried interest arrangements and dual contracts arrangements. So far we have not seen a single arrangement aimed at or being considered for general availability as part of employment arrangements, other than as mentioned below.
2. Employment rights are contractually written back in
Even in the often described cut throat world of private equity, development of good and bad leaver protections have the effect of contractually writing back in protections such as redundancy payments. Beecroft’s idea of no fault dismissal termination payments appears to have been picked up by those implementing employee shareholder arrangements to the extent that the no fault (good leaver) provisions end up being broadly equivalent to where one might expect that awards for unfair dismissal would end up. These no fault dismissal payments have been given from day 1. Oddly, therefore, the employee shareholder arrangements in some cases have lead to an increase in employment protection, via the contract.
3. When it’s not all about the tax, it might be about the third sector
While Community Interest Companies are prohibited from having employee shareholders, this is not the case for all mutual arrangements. The employee shareholder route enables, for example, a spin out from the public sector to take the possible redundancy costs out of its projected financial requirements and therefore present a different balance sheet picture to increase the financial viability of the entity. This then gives the organisation the ability to, for example, raise more money.
4. Valuing the shares is tricky
As the benefit for the employer of reduced rights only applies where the shares are worth at least £2,000, there is a key focus on ensuring the shares are valued appropriately above this level. As such, the ones we have seen tend to have an interest which is likely to be significantly above the £2,000 level or have a value manipulated through the company’s articles to ensure at least that minimum. What’s also clear is that the accountancy fees for valuing the shares in most arrangements means that unless there are a few employees involved, this is unlikely to be a cost effective approach.
5. Employee legal fees on getting the appropriate advice are significant.
Compared to the cost of getting advice on compromise agreements, the cost to employees of getting appropriate advice on the arrangements to satisfy the legislative safeguards has been significant. Query whether this is because the first employee shareholders are, in effect, paying for their employment lawyers to learn “on the job”. We expect that an astute employer would present the package of documents and possibly pre-brief the employee’s legal adviser.
6. Corporate implementation can be tricky.
In the context of the sometimes complex structure in buy-outs, buy-ins etc, shoe-horning in employee shareholder shares, managing for them to have the requisite value and enabling them to be paid up from reserves (or creating resources from which they are paid up) is not straightforward. Better thought about early in the process, rather than as a bolt-on “nice to have” at the end.
7. Just to re-emphasise – It’s all about the tax
No really. The motivation is not to do with “cheating” individuals out of employment rights.
Employee shareholder arrangements are likely to remain niche. They are unlikely to be picked up unless tax or other drivers are present. With the exception of their possible use in the third sector, the arrangements are being used to maximise tax planning for those earning or likely to earn sums significantly above usual employee wages. Whether we see a second wave of arrangements in due course with the motivation being avoiding employment rights is debatable. The complexity, set up cost and problems in valuing the shares all suggest employee shareholder status will remain the preserve of those earning many times the average national wage.