BIS guidance on employee shareholder status

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We have previously described the Government’s new “shares for rights” scheme and the opportunities the new scheme may present for the private equity community. Some aspects of the scheme were still a little unclear as at 1 September 2013; hence, the Government’s attempt at clarification through its guidance.

In reality, the guidance does not tell us much that we did not already know. One point, however, is worth noting.

It is clear from the legislation that the company issuing shares may not receive any other form of consideration from the employee other than the renunciation of certain of his or her statutory employment rights identified in the legislation. The BIS guidance states that the requirement that the shares be issued fully paid means that companies will, in the majority of cases, have to issue those shares by way of capitalisation of distributable profits.

A capitalisation of distributable profits brings with it the following considerations for the issuing company:

  • the articles of association must permit the appropriation of capitalised sums to non-members. Article 36(1)(b) of the Model Articles for private companies permits the appropriation of capitalised sums “to the persons who would have been entitled to it if it were distributed by way of dividend” – i.e. members, not non-members
  • the company will only be able to allot and issue fully paid shares from capitalised profits and distributable reserves to the extent that there are adequate sums standing to those profits or reserves at the relevant time
  • the value of shares held by existing members is likely to be diluted by a bonus issue to the employee shareholders.

The guidance confirms that individuals are not obliged to apply for, or to accept, an employee shareholder contract and existing employees that are asked to change their contracts to those of employee shareholders are entitled to refuse to do so, and can complain to an employment tribunal if they suffer any detriment as a result of such refusal. Employers that wish to offer employee shareholder contracts to existing employees must follow the same procedures as when offering contracts to new starters.

The guidance sets out the conditions that must be satisfied before an individual can become an employee shareholder. These are:

  • mutual agreement
  • receipt of fully paid-up shares in the company worth at least £2,000 for which the employee has not paid in any way (other than by renunciation of certain of their statutory employment rights)
  • the issue of a “written statement of particulars” of the status of employee shareholder from the employer to the individual
  • independent advice on the terms and effect of that status, paid for by the employer
  • a seven-day cooling off period.

Responsibility for satisfying these conditions is shared between the employer and the individual.

The guidance also confirms that the employee retains their status as an “employee shareholder” even after they have disposed of their shares. The only way that they can lose the status is if the employment contract is varied.

Separately, HMRC have announced that they will provide a facility for agreeing the market value of the shares for employee shareholder agreements in the same way that they agree market values for share plans such as Enterprise Management Incentive (EMI) options. This will not be compulsory, but is likely to be used by both the employing company and the employee shareholder as it provides certainty. As such, it is a welcome development. Note that neither the BIS guidance nor the HMRC guidance tackle the question of the price that companies must pay when the shares are forfeited, nor do they stipulate that a reasonable consideration should be paid when shares are bought back by the company.

WM comment
So far the response from business to the new scheme has been muted. However, for dynamic management teams in companies with significant potential for rapid capital growth, the benefits highlighted in our earlier article, particularly the CGT exemption, may be a real attraction and deserve careful consideration.

The BIS guidance can be accessed here.