As part of the Government's long-term plan to stimulate the growth of small and medium-sized enterprises (SMEs) and to generally boost the UK economy, it is proposing to create a new class of employees, "Employee Owners," who in exchange for forgoing certain employment rights will receive shares in their employer companies. To make this concept more viable, the Nuttall Review recommended that the regulatory regime for share buy-backs under the Companies Act 2006 be relaxed.
On 30 October 2012, the Department for Business Innovation & Skills (BIS) published a consultation paper which invited opinions on the relaxation of the current share buy-back regime. Draft amendments to Part 18 have been laid before Parliament with the intention of bringing the revised regime into force on 6 April 2013. However, with this date looming and with no formal response to BIS's consultation published, the details of how Employee Ownership will work in practice remain unclear.
Employee Owners – the concept explained
The concept is simple. In exchange for forgoing their employment rights to:
- statutory redundancy pay;
- claim unfair dismissal (except in limited circumstances including TUPE);
- request flexible working hours or time off for training,
and by agreeing to provide enhanced notice of an early return from maternity leave, Employee Owners will receive shares worth between £2,000 – £50,000 in the company that employs them. Should Employee Owners wish to dispose of their shares in the future, such disposals will not attract capital gains tax (CGT).
Whilst existing employees cannot be forced to become Employee Owners, employers can make this a condition of employment for new recruits. Note, however, that employees cannot be given shares in an employer's existing share scheme when giving up these rights. Instead, a new share scheme must be set up if employers are to adopt the Employee Owner concept.
Amendments to the current share buy-back regime
Share buy-backs are key to the Employee Owner concept since companies will be keen to avoid becoming majority-owned by ex-employees. To encourage participation and to provide companies with comfort regarding departing Employee Owners, a simple and effective share buy-back regime was seen as essential by Government. However, the Nuttall Review found the current regime to be 'over-burdensome' and recommended that:
- the current requirement for off-market share buy-back agreements to be approved by 75% of a company's members be replaced with a requirement for approval by a simple majority of the members;
- the requirement for companies to pay the full price on the purchase of shares be replaced with a provision allowing companies to pay in instalments where the buy-back is associated with an employee share scheme;
- the provision allowing public companies to hold re-purchased listed shares in treasury following a buy-back be extended to private companies; and
- more funding options be made available to private companies on share buy-backs in addition to the ones which are currently available (i.e., distributable profits, the proceeds of a fresh issue of shares or out of capital).
Recommendations (i) – (iii) form the content of the draft bill currently before Parliament. If the proposed amendments become law, it would certainly be easier and more financially attractive for private companies, particularly SMEs, to finance share buy-backs. The ability to hold re-purchased shares in treasury rather than having to continuously cancel and issue new shares will reduce administration and the ability to pay for re-purchased shares in instalments will benefit cash flow. However, it is questionable whether the Employee Owners concept, the very motivation behind these amendments, is itself a viable concept.
Flaws of the concept of Employee Owners
The Employee Owner concept has been heralded as beneficial to both Employee Owners and employer companies. The theory goes that Employee Owners, as shareholders, care more about the success of the company that employs them, whilst employer companies, emancipated from red-tape through reduced administration and less stringent employment law compliance, are freed up to focus on the growth and success of the business.
This is great, in theory, however a number of fundamental concerns and questions regarding Employee Owners have been flagged, which to date remain unresolved:
Taxation
The sale of Employee Owner shares will not attract CGT. However this 'benefit' will be of little consequence to Employee Owners with small holdings, the sale of which is unlikely to generate a gain that will exceed the CGT annual allowance of £10,600. Government has also indicated that the shares issued to Employee Owners will be treated as taxable income. Thus, an Employee Owner issued with shares worth £10,000 would incur an immediate tax liability of roughly £3,000, assuming the Employee Owner in question is a lower rate tax payer. This is in contrast to more traditional employee share schemes where tax is often deferred.
Unless taxation is reviewed, companies embracing the Employee Owner scheme may struggle to attract new recruits. Ironically, the current tax proposals will be more appealing to those in senior positions, who may be more able to foot an immediate income tax bill and more incentivised by the prospect of maximising their CGT relief, than those in junior positions.
Business transfers
It is proposed that Employee Owners will retain their status as such after their shares are sold. This remains so even if, on a share sale, an Employee Owner is forced to sell their shares under a drag-along provision. Post-share sale, the Employee Owner will be neither an employee with full statutory employment rights nor will it have a shareholding in the employer company. It is also unclear what will happen if, on an asset sale, an Employee Owner is TUPE transferred to a company which does not endorse Employee Owners.
Valuation
Currently, the process for valuing shares in private companies is rather arbitrary and establishing a fair value can prove difficult. To date, Government has provided no guidance on how Employee Owner shares should be valued when sold. Unless regulated, this is likely to cause considerable conflict, although the introduction of a new share valuation process for limited companies would fly in the face of Government's desire to reduce red tape.
Waiver of employment rights
It is unclear whether Employee Owners should be given information and/or guidance before becoming such. Advance guidance is currently provided to employees surrendering their employment rights under a compromise agreement but no such process has been proposed for employees contemplating joining an Employee Owner scheme. The benefit of Employee Owner schemes to companies has also been questioned since statutory redundancy pay and, for those hired after 5 April 2012, unfair dismissal protection, are only triggered after two years' service. It is questionable why companies would dilute their shareholdings in exchange for rights that in some cases have not yet arisen.
Comment
If achieved, an increase in company prosperity and a more incentivised workforce would be a massive boon to the UK economy. However, given the number of unresolved key issues, one can't help but feel that the Employee Owner ideology has been hurriedly converted into legislation which doesn't quite cover all bases. If rushed through, Employee Ownership runs the risk of creating more problems than it purports to cure.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
