It is becoming more common for employees to be given shares in the company they work for. Sometimes this happens through a formal scheme like EMI options, other times it is a simple issue of shares to key staff. The idea is to make employees feel invested in the company’s success and to reward them if the company grows.
That works well while relationships remain positive. But difficulties can arise when an employee-shareholder leaves the business or when there is a wider shareholder dispute. At that point, the key question is: what are those shares really worth?
And when you are both an employee and a shareholder, the answer is rarely straightforward. In this article, I look at what happens when a company wants to part ways with an employee shareholder.
Incidentally, I recommend you do not give shares to employees without reading this article first.
Two roles, two sets of rights
An employee-shareholder is in a dual position.
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As an employee, they have rights under their employment contract and employment law, such as notice pay, benefits during the notice period, and possibly redundancy or unfair dismissal compensation.
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As a shareholder, they have rights under the Companies Act 2006 and the company’s constitutional documents, such as articles of association and shareholders’ agreements.
For companies, this means that the departure of an employee-shareholder cannot usually be resolved simply by ending employment. For individuals, it means that losing a job does not automatically strip away shareholding rights.
Employment entitlements
When employment ends, certain payments are usually due to employees:
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Notice – either served or paid in lieu.
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Benefits – continuation of benefits such as pensions or healthcare during the notice period.
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Compensation – potentially redundancy or a basic award, or damages for unfair dismissal if termination is challenged.
These rights are separate from the value of the shares and need to be dealt with in parallel.
Leaver provisions and shareholder documents
Most businesses anticipate that employee-shareholders will eventually leave. The company’s articles of association or shareholders’ agreement often include leaver provisions.
These usually distinguish between:
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Good leavers – typically those leaving through retirement, ill health, or after a defined service period. They may be entitled to sell their shares at fair market value.
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Bad leavers – typically those dismissed for misconduct or who resign to join a competitor. They may only receive nominal value or the original subscription price for their shares.
This distinction can make a dramatic difference to outcomes. Employers rely on it to protect the business from disruptive exits, while employees are often surprised at how little their shares can be worth in certain circumstances.
But if you don’t have these in place because you just issued shares to an employee, then you cannot rely upon them – there are no real rules.
So that means one of a couple of options:
- An agreement is reached to buy the shares AND terminate the employment
- A dispute arises as to value
- A court claim is required.
How valuations are carried out
Where shares are to be valued, several approaches are commonly used:
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Fair market value – the price a willing buyer would pay a willing seller, both acting reasonably.
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Net asset value – the value of assets minus liabilities, suitable for asset-heavy companies.
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Earnings multiples – often based on EBITDA, applying an industry-standard multiple.
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Discounted cash flow – future profits are projected and discounted back, less common in small private companies.
A further consideration is whether a minority discount applies. A 10% stake is rarely worth 10% of the company’s overall value, because small holdings often lack control or influence.
All of these have such wide variables that I would always recommend independent valuation advice to be obtained – although there’s a cost to this, if the parties can agree jointly to instruct someone and then stick to their valuation, it would make life a lot easier!
What if there is no clear agreement?
If the documents do not contain leaver provisions, matters can become uncertain. A company may have no mechanism to force a departing employee-shareholder to sell, and the individual may be unwilling to sell at the price offered. This often leads to stalemate and, if unresolved, dispute.
Litigation – the last resort
If negotiation fails, disputes sometimes reach court. The most common route is an unfair prejudice petition under section 994 of the Companies Act 2006. A shareholder can claim that the company’s affairs are being conducted in a way that unfairly prejudices their interests.
Courts can order a share buyout at “fair value”. Whether minority discounts apply depends on the circumstances. For example, if the business operated like a quasi-partnership, courts may refuse to apply a discount.
However, litigation is expensive, lengthy, and uncertain. Expert valuations are often contested, legal fees escalate, and the business itself can suffer from the distraction. For both companies and individuals, court is generally the worst option and should be treated as a last resort.
Settlement – the best option
The far better route is usually negotiation. A practical settlement often includes:
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Valuation – either agreed directly or determined by an independent accountant.
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Employment settlement – compensation for employment termination, usually documented in a settlement agreement that waives employment law claims. £30,000 can be paid tax free under a settlement agreement, provided it is genuine compensation and not a diverting of price away from shares.
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Share sale – documented in a share purchase agreement (SPA), which records the price, number of shares, and any warranties about ownership.
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Stock transfer form – the legal document transferring ownership of shares, which must be lodged with the company and reflected in the company’s confirmation statement at Companies House.
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Board/shareholder resolutions – to formally approve the transfer.
This package allows for a clean break: employment rights are addressed, shares are transferred, and the parties move forward without lingering disputes.
Mediation and negotiation
Mediation is often highly effective in shareholder disputes. Because valuation is rarely an exact science, there is usually scope for compromise. A mediator can help both sides explore settlement options that balance employment compensation with share value.
Businesses benefit by protecting their reputation and continuity. Individuals benefit by avoiding the time and stress of litigation.
Tax treatment
The structure of a settlement also affects tax:
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Employment payments – subject to PAYE and NICs, though the first £30,000 of a genuine termination payment may be tax-free.
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Share sale proceeds – generally subject to capital gains tax. Business Asset Disposal Relief may reduce the rate to 10% if conditions are met.
Both sides need to factor tax into negotiations.
Practical points for both sides
For companies:
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Check the shareholders’ agreement and articles when issuing shares to employees. Clear leaver provisions can prevent later disputes.
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If a dispute arises, consider early negotiation rather than risking court.
For employees:
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Understand the small print before accepting shares. Do not assume they will always be worth market value on exit.
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If leaving, calculate both employment entitlements and potential share value before entering negotiations.
For both:
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Take early advice.
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Consider mediation.
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Treat court as a last resort.
Conclusion
Employee-shareholders bring unique challenges when disputes arise. There are two roles and two sets of rights: employment and shareholding. Both need to be addressed, and neither can be ignored.
The value of shares depends on the documents, the valuation method, and the context. Employment rights add another layer of complexity.
The best outcomes come through negotiation, documented in settlement agreements, share purchase agreements, and stock transfer forms. Court is expensive, uncertain, and damaging to all involved.
Whether you are a company dealing with a departing employee-shareholder, or an individual leaving a business in which you hold shares, the message is the same: understand your position early, seek professional advice, and aim for a negotiated solution that achieves certainty for all parties.
I’ve helped many companies and individuals involved in shareholder disputes and the sale of shares following a dispute, and the exiting of employees by settlement agreement – get in touch today for help.