Share schemes can be a great way to incentivise employees to grow the value of your business. But structuring share schemes incorrectly can actually have the opposite effect on productivity if employees feel the scheme doesn’t match what they were promised. A perfect example of this are the employee shares in BrewDog, which were touted as being worth a six-figure sum, but which according to the Financial Times “will probably be worthless” (please note this Financial Times article requires a subscription).
Why offer shares to employees in the first place?
A business owner goes that extra mile because they know that (generally speaking) the greater effort they put in, the greater reward they get out. This is because, through share ownership, they are entitled to the financial benefits from the company. If employees have (and feel like they have) that same ability to share in the rewards from their hard work, they are incentivised to work harder.
With recruitment and retention being one of the biggest problems facing businesses, having an attractive share scheme for employees can help alleviate these problems.
What types of share schemes are available to businesses?
There are many different ways for structuring share schemes, but all of these broadly fall into two categories:
- Immediate Share Ownership: Employees receive actual shares in the company straight away. These are often referred to as “growth shares” as the employee will only receive any value if the company grows in value, and the shares are sold in excess of a predetermined exit price.
- Share Options: Employees don’t receive shares straight away, but instead receive an option to acquire shares in the future at a fixed price if certain triggers are met. Examples of these are “EMI options” and “CSOPs” which are essentially just share option schemes but with favourable tax treatment. It is only once the share option is exercised that the employee receives any shares.
Do employees have to pay for shares when they receive them?
Any shareholder has to pay at least a nominal amount when they receive their shares, and employees are no different. Broadly speaking if an employee pays less than market value for their shares, they can be liable to pay income tax on the difference between what they paid and that market value. However if the share scheme is structured correctly, it is possible for any gain to be subject capital gains tax rather than income tax (which will usually result in both the employee and company incurring less tax in relation to the scheme).
What can go wrong with improperly structured share schemes?
The employee shares in BrewDog are an example of where the value employees thought they had, has now been reported to “probably be worthless”. In 2022, the founder of BrewDog James Watt announced he was gifting £100 million of his own shares to the company’s employees, incentivising the employees by saying that if the company performed well, these shares could be worth £120,000 or maybe even more to each employee.
However, the devil is in the detail. Even if there was a successful exit with the company being sold for its current valuation of around £500 million, the employee shares sit behind the preference shares which private equity firm TSG holds. TSG paid £213 million for these preference shares in 2017, but due to an eye watering 18% per year compounding return attaching to these shares, their shareholding is now worth over £800 million.
This is why the Financial Times is report that these employees share are effectively worthless, as on a sale for market value TSG would hoover up all of the proceeds.
For the employees of BrewDog who had a £120,000 carrot dangled in front of them, this can’t be anything other than massively demoralising. Their hoped £100 million shareholding may well now have a detrimental impact on moral, rather than being the incentive it was intended to be.
Practical tips for getting it right from the start
To prevent negative consequences arising in the future, there are some key considerations for structuring share schemes:
- How will employees realise the value of their shares? Make sure there is a clear mechanism for sale, so employees understand the triggers they are working towards before they see any value.
- What tax will the employee incur as a result of receiving any shares or share options? Ensure employees understand the tax they may have to pay so it doesn’t come as a nasty surprise.
- What happens to the employees shares if they left the business? Unless there is specific wording to the contrary, an employee would be entitled to keep their shares regardless of the manner in which they left.
- Should the majority shareholders have the right to drag employee shareholders along if they wanted to sell the business? Without an explicit right, majority shareholders could be powerless to stop an employee shareholder sinking a sale if they refused to sell their minority shareholding.
Specialist legal, accounting and tax advice is therefore crucial when structuring share schemes (otherwise employees might feel Punked). Our Corporate team can help if you have any questions regarding share schemes.