Following its launch at the beginning of September, the controversial ‘shares for rights’ scheme has reportedly already been used to incentivise senior management in the private equity context on Equistone’s recent acquisition of Whitworths from European Capital. So what advantages does it offer, and should you be thinking of using it?
‘Shares for Rights’
Employers are now permitted to give an employee shares in the employer’s business in return for that employee giving up some fundamental employment rights. Such employees have a new employment status: the ’employee shareholder’. Shares awarded under the new arrangements enjoy generous tax reliefs. Although new hires can be required to join on an employee shareholder basis, existing employees cannot be forced to change their status and switch to employee shareholder contracts.
What rights are given up?
Employees will primarily give up the right to sue the employer for unfair dismissal and to receive a statutory redundancy payment. In addition, they will forfeit rights to request flexible working or time off to study or train. Employee shareholders will also be required to provide their employer with extended notice (16, rather than 8, weeks) of when they intend to return from maternity, additional maternity (or adoption) leave. However, employees will not lose the right to make claims for discriminatory dismissals and/or dismissals related to whistleblowing or other automatically unfair reasons.
What shares need to be given in exchange?
In return, the employer must give the employee fully paid up shares (in either the employing company or its parent) of a minimum value of £2,000.
Are there any legal / administrative issues?
There will clearly be legal and administrative costs in implementing the structure. In addition, in order to address concerns surrounding the proposals, and protect employees interests, employers must:
- explain the rights being given up;
- provide written details of the shares being offered and the rights and restrictions attaching to them;
- give a 7 day cooling off period; and
- ensure that the employee/prospective employee receives independent legal advice before they accept the offer, and meet the reasonable legal fees thereof.
There are tax advantages for employees taking up this new employment status:
- the first £2,000 worth of shares may be given to the employee free from income tax and NICs (but any value over £2,000 will be subject to income tax and NICs); and
- any gain the employee makes when they later dispose of the shares is exempt from capital gains tax (to the extent that the shares were worth no more than £50,000 when they were acquired).
Will the new employee-shareholder status prove attractive?
An employer will need to consider whether the types of employee they are looking to recruit will want the new status. It is likely to be more attractive to senior employees, who are less concerned about retaining unfair dismissal and redundancy protections and are keen to have tax efficient equity participation, than more junior staff.
The benefits for the employing company include potential cost savings as a result of the reduced employment rights. In practice, though, this is likely to be limited given the exclusion of discrimination and whistleblowing claims from the scheme.
The disadvantages are the legal and administrative costs of implementing the structure and advising prospective employee shareholders. In addition, if the company is not listed, the valuation of shares given to employees may prove complex. If the £2,000 minimum threshold is not reached, the employee’s waiver of rights will be rendered ineffective and the tax advantages lost.
Increasing share ownership generally can also have its own issues. For example, companies will need to consider whether, and for how much, the shares can be bought back on termination of employment (and this can itself have an impact on the initial valuation of the shares, as well as requiring further ongoing valuations). And if the shares are to be bought back for, say market value, where will the resources be found to do this?
In practice, the new status may well be attractive to companies with significant potential for capital growth that are already using equity to incentivise and reward key personnel (or are thinking of doing so), and have experience dealing with the valuation and other practical issues that arise. Many employers may take the view, however, that the benefits offered as a result of the reduced employment rights do not outweigh the costs and other difficulties of putting in place such arrangements, in particular for lower paid employees.
In this context, it is not surprising therefore that the first use of the scheme has been by the private equity industry to “[give] management an incentive to grow the business”, with no other employees being asked to give up their rights.