Employee engagement through economic and fiscal incentives

Employee ownership and engagement schemes have a long history, driven by enlightened employers and government incentives. Yet the way businesses incentivise and engage with their employees is changing – a voice or a seat at the table is often as important as having an economic stake in the company.

As new generations enter the workplace and with new ways of working becoming increasingly normal, businesses will need to find innovative ways to attract, retain and reward their staff.

In this, the first of two articles, we remind businesses how they can use the more traditional economic and fiscal measures to incentivise staff. A second article here explores the ways businesses can use engagement and influence to motivate and build better relationships with their employees.

Economic incentives are usually linked to some form of equity in the business. This will typically focus on:

• Direct share ownership
• Options, or
• Growth shares.

Direct share ownership

Employers sometimes see direct share ownership as the most straightforward way of rewarding and incentivising their employees: upon receipt, the employee will have voting rights in the company, a potential short-term financial incentive in the form of dividends and the long-term incentive of a share of any sale proceeds if the company is eventually sold.   

Whilst the immediacy and tangibility of direct share ownership can be appealing, the long-term consequences for the employer and the limited influence they provide employees in respect of the running of the company need to be considered. 

The employer will also need to consider and provide for future scenarios:

• What happens if the employee leaves the company? Should the employee be forced to give up the shares and if so, at what value? Does the value differ if the employee is a ‘good leaver’ or a ‘bad leaver’?
• Could the employee use their voting rights to block any action, for example, a future investment, or disrupt a potential sale of the company down the line? Can the employer force the employee to sell the shares in the event of a sale of the company through ‘drag along’ provisions where the majority vote can drag along a minority?

From the employee’s perspective, does share ownership really give them the voice they desire?  Employee shareholdings are invariably minority stakes and confer little influence over the day-to-day operation of the company. For example, unless specifically provided for in the company’s constitutional documents, such minority holdings would not confer board attendance rights or the ability to block corporate actions.

There are then the practicalities of getting shares into the hands of employees without incurring significant tax/NIC liabilities for both employer and employee. An employer should never gift or otherwise transfer or issue shares to an employee without understanding the tax consequences first.

Options

An option over shares provides the holder with the right to acquire those shares at some point in the future and can be unconditional or conditional on certain performance targets or other requirements being met.

Options enable employers to incentivise employees to remain with a business and contribute to its growth on the promise of future financial benefit without surrendering control over the voting rights or having to deal with the practicalities of retrieving shares from employees who leave the business prematurely. 

There are various HMRC backed schemes, such as Enterprise Management Incentives, or EMI, that can allow employees to obtain options and any resulting shares in a tax-efficient manner, but options granted outside these schemes can be very tax-inefficient.

Growth shares

Employers who do not qualify for an HMRC approved option scheme can turn to growth shares.

Growth shares come in different guises, but they aim to reward holders for growth in value above a specified hurdle. Whilst the benefit is not usually realised until an exit, the immediate allotment of the shares can help to achieve a commitment to the commercial objectives of the business and there is significant flexibility in the rights attaching to those shares (eg voting or non-voting; dividend participating or non-participating).

Whilst growth shares can be used to give a more meaningful stake in the company than options (if the growth shares are voting and dividend participating), as with direct share ownership, the reality of that stake can mean little when it comes to a voice in or influence over the business.

Again, the tax consequences of the issue of growth shares should be fully considered, however, they can usually be designed to achieve tax efficiencies.

In the second article, we will examine the measures businesses can adopt to incentivise staff through engagement and influence.

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There is no “one size fits all” solution to employee ownership and all schemes come with their own pros and cons. This article only touches on a few options and there are many other vehicles you can use to promote share ownership and incentivisation.

At Fox Williams, our corporate, tax and employment specialists work together to advise clients on structuring and implementing bespoke and tax efficient employee incentives, ownership and engagement structures.