It is, however, fraught with issues. Gifting shares to employees gives rise to tax issues but more fundamentally if they are not done properly, you could end up paying serious sums to them to buy back their shares.
Don’t just give employees shares without any legal documents
I’ve seen it a number of times before. The company (usually wanting to save a little tax) decides to give a senior-ish employee some “B” or “C” shares in the company, as a way of paying the employee via dividends rather than PAYE.
While that alone may cause some problems down the line with HMRC (I’m not here to advise you on tax!), it is usually done without any legal paperwork in place. The employment contract doesn’t mention it, there’s no changes to the articles of association or no shareholders agreement in place. It’s not been thought through by anyone.
Sometimes, to ‘protect’ the company, the new shares issues are “Non-Voting” and they are only getting 1 share or 2.5% of the shares, or some other ‘small amount’.
But what they fail to realise is that without legal provisions in place, those B or C Shares are still shares in the capital of the business and that shareholder now owns 2.5% of the business.
Sure, you can be flexible on your dividend policy and pay them as you see fit.
But it is when the business gets sold that things usually rear their ugly head. Sometimes it is when the employee shareholder leaves, they then question what their shareholding actually means.
And they can be difficult to overcome. Admittedly, such a small percentage in a private business will usually be worth very little, given the rights which attach (or not) to the shares. It’s certainly not a straight 2.5% of the business valuation – usually there is a minority shareholder discount applied which is probably quite high.
However, there is still a process (and often payment) involved to have the shares transferred back.
A better approach to gifting shares
A better approach to a simple gift of shares to an employee is to document it.
It is usually better to issue new shares than gift shares from existing shareholders, as the latter would be a disposal and give rise to a potential capital gain.
So when issuing new shares, we’d look to document that properly through shareholder and director approval after considering the Articles of Association.
Before we allot the new shares to the employee, you should also consider whether you need new Articles of Association to govern the new shares. It may be together with a shareholders agreement, we can include provisions known as “good leaver/bad leaver” provisions. We also include attorney provisions which allow another person to sign on behalf of the employee. Within the articles and shareholders agreement we can also have various pre-emption rights which restrict what the employee can do with their own shares.
Other options for employee shares
There are a number of alternatives for giving shares to employees. These include:
- EMI Schemes
- Phantom / Growth Share options
Some of these only apply to listed companies. But the one we see used the most in small and medium sized businesses are EMI Schemes.
Enterprise management incentives (EMI) options
EMI options enjoy favourable tax treatment and are specifically targeted at small, higher-risk trading companies. A number of statutory requirements must be met in order for a company to qualify to grant EMI options. In particular, a company must be an independent trading company with:
- Gross assets of no more than £30 million.
- Fewer than the equivalent of 250 full-time employees.
Certain trading activities will not qualify and there are detailed rules relating to the independence requirement, the trading requirement and the shares that can be used. Where all the requirements are met, the exercise of the option benefits from favourable tax treatment. In addition, shares acquired on the exercise of EMI options may qualify for business asset disposal relief.
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