The Employee Shareholder Scheme – Good or Bad?

Posted by David Cammack on 29th March 2018

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Back in 2013, under the coalition government, SMEs in the UK were presented with a new way to get employees on board with share schemes, the Employee Shareholder Scheme. Designed to enable SMEs to grow and expand without the factors that typically have hindered smaller businesses, their goal was to provide a newer, better, way for SMEs to operate as Employers looking to get the best staff whilst protecting their own interests. In reality Employee Shareholder schemes haven’t really taken off.

What is an Employee Shareholder?

Employee Shareholder Schemes are aimed to increase flexibility of the employer, most notably SMEs including start-ups. The concept is that smaller businesses will be more inclined to take on new employees if their risks of doing so are reduced.

Therefore the fundamental tenet of the Employee Shareholder scheme is that, in return for forfeiting certain employment rights, the employee is offered some free shares in the company – at least £2,000 worth of them. Prior to 1 December 2016, the first £2,000 of such free shares per employee was exempt from income tax and National Insurance. Additionally, any gain made on shares up to £100,000 (link: http://www.gabelletax.com/blog/2016/03/16/budget-2016-restrictions-on-relief-under-employee-shareholder-status-ess/) is exempt from Capital Gains Tax for shares issued after 16 March 2016 (rates correct at the time of publishing).

However, they say there is no such thing as a free lunch and these free shares are no exception. In return for the shares under this scheme, the employee waives certain fundamental employment rights. This includes the right to claim most forms of unfair dismissal and the right to receive redundancy pay. These are two known areas that sometimes put SMEs off recruiting new staff because of fears of future unknown costs. In addition, employment rights are waived for time off for training, flexible working requests, and other specific issues, such as implementing an extended notice of return to work in the case of maternity leave.

The Benefits to the Employer of an Employee Shareholder

The premise behind these schemes is that employees with a vested interest in the company will be more dedicated, loyal, and incentivised to promote productivity and growth. They remove risk, most notably financial risk, by ensuring SMEs can recruit knowing they are not liable for certain types of statutory redundancy payments and unfair dismissal awards.

In addition, time is saved for management, as they no longer need to spend time considering, for example, flexible working requests or training requests.

How to Implement Employee Shareholder Schemes

Once the share valuation for the purpose of the scheme has been ascertained (which isn’t always straightforward), the employer needs to decide factors such as voting and dividend rights. From here, the employer also needs to make sure they pay heed to other points.

Employers must provide the employee, or potential employee, with a detailed written statement with full details of the rights being given away by the employee in return for the free shares, as well as information on the shares offered. The individual must then, with costs borne by the employer, seek independent legal advice in connection to the rights they are giving up. In addition, there is a seven day ‘cooling off’ period where the acceptance isn’t binding.

The Realities & the Downsides of the Employee Shareholder

In reality, take up of the Employee Shareholder scheme has been very poor. Only a fraction of share valuations in connection with Employee Shareholders have been agreed with HMRC. Indeed, it is the complexity of getting accurate share valuations that has most likely put many employers off.

Additionally, businesses that have introduced it have limited it to specific employees, usually those with a specific role in business success. The result can be a two-tier system that becomes an unwieldy beast to tame in terms of administration and employee satisfaction and morale.

Most notable is the adverse effect on an employer’s reputation. Offering a scheme that at the first hurdle involves employees meeting with a solicitor to sign away their rights is not particularly attractive to many, especially without the ability to weigh up the financial gains, which could prove to be a bit of a lottery.

In the real world, the administration costs, particularly of covering the costs of the solicitor when a new recruit may still turn down the offer, are off-putting to the employer.

Are There Better Options than Employee Shareholders?

Almost certainly the answer here is “yes”, and the poor uptake of the scheme reflects this.
There are three main alternatives to Employee Shareholders that are considerably more popular and can incentivise and reward employees well, without the unpleasant sting of requiring them to give up key employment rights.

1. Enterprise Management Incentives (EMI Options): this is an employee share scheme that is very tax-efficient and HMRC-approved. It works by employees being granted options to purchase shares in the company that vest at certain events, e.g. the sale of the company. Up to quite large amounts of shares can be given out using this scheme, making it very suitable for incentivising small numbers of key or senior employees in any size of company. This scheme has been far more popular due to its great tax breaks and flexibility.

2. Share Incentive Plans (SIP): these plans allow employees to acquire actual shares rather than options and there are four distinct types: Free Shares; Partnership Shares; Matching Shares; and Dividend Shares. The downside is that only comparatively small amounts of shares can be given out under this scheme, so it is not nearly as flexible or popular as the EMI scheme above. It is most suitable to large employers giving small numbers of shares per employee out across a large employee-base.

3. Company Share Option Plans (CSOP): CSOPs are more discretionary, allowing the employer to decide specifically who to incentivise and are therefore still a useful tool if your business doesn’t qualify for an EMI scheme.

Additionally, there are various unapproved share schemes that can prove to be worthwhile flexible solutions for employers, but do not have the tax-efficiencies of the above HMRC-approved schemes, so the tax element is far more expensive for the employee in the end. These are only generally used if you do not qualify for one of the tax-efficient schemes above.

The Future of the Employee Shareholder Scheme

For the time being it seems unlikely that there will be radical change in the scheme which would lead to an increase in the numbers of SMEs choosing to go down this route. Instead it seems far more realistic that SMEs will stick to the known and favoured alternatives, like the EMI scheme, that not only reward and incentivise key personnel, but also boost, rather than hinder, staff morale and the company’s reputation.

If you are considering setting up a share reward scheme for all your staff or just for key employees, then please get in touch with us.