Giving employees a piece of the pie

How a well-planned employee share ownership scheme could help your business navigate the current economic climate

Introduction

If high staff turnover and a lack of motivation among employees sounds familiar, it might be time to consider using an employee share ownership plan (ESOP) to boost engagement.

ESOPs foster a sense of ownership among employees and motivate staff members to succeed. They often serve as an effective way to keep valuable staff at the business and align the employee’s long-term objectives with those of the business.

ESOPs can take a wide variety of forms and can be tailored to fit the needs of both the employer and employee. However, before you give away a piece of your business, there are a number of things to consider when deciding whether to implement an ESOP.

Assessing suitability for an ownership role

As legal owners of a company, shareholders have different rights, powers, and obligations to ordinary employees. They have influence over key matters facing the business including approving high value transactions, mergers, amendments to company rules and whether the company should be wound up and put into liquidation. Becoming a part owner therefore often requires additional skills and a change in mentality from being an employee.

An employer must evaluate if the employee in question is suitable for the different demands and increased responsibility the shareholder role requires. Adjusting to a new role is difficult, and some people might struggle to separate their roles as employees from their obligations and responsibilities as shareholders.

Designing an effective scheme

It is important to choose what type of ESOP scheme is best suited to your business. Employers can tailor their ESOPs to fit their goals and objectives by adjusting key features including:

• The eligibility criteria for participation: should all employees be entitled to own shares to foster a sense of unity, or should shares only be offered to managers to encourage upward mobility within the company?
• Vesting periods: the length of time it takes for shares to ‘vest’ in the employee (in other words, for ownership to pass) and the price payable for the shares often has tax consequences, both for the employer and employee.
• Any performance-based conditions: tying an entitlement to be offered shares to job performance is often an effective motivational tool.

It is crucial to strike a balance between providing incentives and aligning with the company's long-term success.

Financial tax considerations and legal compliance

Before implementing an ESOP, employers and employees should always each obtain tax and accounting advice. This ensures that there are no unexpected financial or tax consequences resulting from the ESOP.

Tax is not the only thing employers should consider. Issuing new shares to employees may require compliance with a range of legislation. Securities legislation may well require employers to disclose certain matters to employees and share issuers may also need to notify certain authorities like the Financial Markets Authority.

Whether an ESOP is captured by financial market regulations depends on a range of matters including the value of the shares being offered, the number of participants in the scheme and the employee’s level at the company.

Documenting the relationship

Before implementing an ESOP, having a well-drafted shareholders’ agreement (SHA) is essential. As each scheme is unique, the SHA should be customised to reflect the specific needs of the business and its new employee shareholders. It is crucial for the parties to engage openly to ensure that the SHA accurately captures the intended purpose and effect of the ESOP.

Some key considerations for the SHA include:

• Decision-making: The SHA plays a pivotal role in establishing the governance framework for the business and outlining the rights (if any) of the employee shareholders to participate in the decision-making process.
• Share transfer and exit mechanisms: The SHA should address how shares can be transferred and provide clarity on any restrictions or pre-emptive rights that apply to employee shareholders.
• Employee departure and misconduct: The SHA needs to set out what happens when an employee leaves the company or engages in misconduct. It may include provisions such as buyback options, forfeiture clauses, or restrictions on how the outgoing shareholder’s shares can be transferred.
• Restraint: Non-competition and restraint clauses will provide additional protection for the business by imposing restrictions on an employee shareholder’s ability to compete in the same industry for a period of time. These provisions can often be more stringent than those commonly found in ordinary individual employment agreements.
• Dispute resolution: Disputes among shareholders can arise in any business venture, regardless of whether the shareholders are employees too. The SHA should outline one or several procedures for resolving conflicts.

Conclusion

ESOPs provide businesses with a means of enhancing staff retention and engagement. The variability of ESOPs means employers can be flexible when providing incentives and are able to align the business’s ownership structure with their long-term goals and objectives. Employers should, however, consider a range of key issues before implementing such a scheme and ensure the key terms of the ESOP are effectively recorded.

Haigh Lyon has extensive experience helping both employers and employees navigate share ownership structures and relationships. For more information, contact Anthony Kuran on 09 306 0611 and @email.