What is an employee share scheme?

An employee share scheme is sometimes referred to using the terms: ’employee share purchase plan’, ‘equity scheme’ or ‘share options’. To put it simply, this kind of scheme is an incentive whereby an employer offers employees the option to purchase shares in the business. The price of the shares may be the market price at the time of the offer or a discounted price, depending on the scheme chosen by the business. Often, shares are offered as part of a reward programme to employees who reach a defined milestone. The equity distributed is the reward. Businesses also align the interests of employees with those of other shareholders with such a share scheme.

There are many types of schemes available. It is important that businesses are aware of all of the types before offering one to their employees to ensure it is the best solution for them. Similarly, considering the pros and cons of such schemes is important before launching them.

How does an employee share scheme work?

Share schemes for employees can seem complex at first. This section provides insight on how company share schemes work. There are two general types of shares:

Ordinary shares

Some companies – usually large ones – give access to what are called ordinary shares. This means that employees have an equity investment in the business.

Dividends only

This is often a model proposed by smaller businesses. They grant dividends to their chosen employees without shareholders’ rights. In this way, the business can retain more control.

There are different ways to pay for each of these share types. They can be paid for through salary sacrifice, over a set period of time, through dividends, a loan, or payment in full upfront. Some businesses grant shares as part of a performance bonus scheme. Usually, access to a share scheme increases employee loyalty and engagement in the business. As such, it influences employee retention and the organisation’s profitability.

The types of employee share scheme

There are several options for companies who want to go down the path of offering an employee share scheme. When choosing the type of ownership they want to offer, businesses should consider several factors, including their size. Let’s dive into the different possibilities below.

 Share award schemes

In share award schemes, the employee is awarded shares as a recognition of their achievement. The value of the share forms part of the employment income. As such, it is generally subject to income tax and to national insurance contributions. This is not the case if the plan is approved by HMRC as a tax-advantaged plan.

Share option schemes

When employees have the right to buy shares in a business at a fixed price, it is called a share option scheme. Once employees have passed their vesting period, they are able to buy shares in the business. Employers can link the option scheme with set goals, such as sales targets. The main point to remember about share option schemes is that when the employee purchases the share, they do so at the price of the share on the date of purchase. The employee can then sell the shares for a profit at a later date.

Share purchase schemes

As the name suggests, this scheme allows employees to purchase shares either directly or by paying a small deposit and the remaining amount at a later stage.

Some schemes are approved by HM Revenue & Customs and therefore have tax and national insurance contribution advantages. They need to meet some qualifying conditions. Other schemes – those that are not approved – do not need to meet those conditions, and therefore might provide more flexibility to employers.

HMRC approved schemes:

• Company Share Option Plans, also called CSOP, are schemes usually granted to selected employees. A Company Share Option Plan can be granted with options up to £30,000 worth of shares each. The share price cannot be lower than the share’s market value on the day it is granted. When the employee sells the share, if they make a profit, there are usually no income tax payments or national insurance contributions due on the gains. Capital gains tax might be payable, depending on the employee’s annual allowance.
• Enterprise Management Incentives schemes, also called EMI, are schemes usually granted to selected employees. This is often the preferred share scheme for private businesses. The value that can be granted to employees can be up to £120,000 and the terms are highly flexible. The employee receiving the shares will only pay taxes when they sell them. Capital gains tax applies to amounts above the employee’s allowance.

What happens when an employee who has shares leaves the company?

It is essential that employers ask themselves what happens to the shares when an employee leaves the business. They should question this before implementing an employee share scheme and should pay particular attention to the option agreement or shareholder’s agreement setting out what happens when an employee leaves the business. The situation might vary, depending on the conditions under which the employee is leaving the business. We explore below the possibilities for options and for shares for both good leavers and bad leavers. A bad leaver is often an employee who has their contract terminated for misconduct. A good leaver is an employee leaving the business for another job, retirement or other personal circumstances.

For options

When the business designs the options available in the scheme, they can differentiate how good leavers and bad leavers are treated. For example, good leavers might keep their options and have remaining options cancelled. A bad leaver might lose all their options.

For shares

Directors of the business may serve notice at any time within 12 months of the employee termination date. This means that the employee leaving the business will need to transfer their shares to the company during that time frame.

Summary of the pros and cons of an employee share scheme

Proposing an employee share scheme needs to be the right fit for your business. Here are some pros and cons of such schemes:

The pros

• Employees are loyal and motivated as they benefit financially when the company performs well
• Retention rate increases, as employees feel more invested in the organisation
• Employees feel valued, particularly when they can buy shares at a discounted price
• The cost to the business is minimised in comparison to a pay rise or cash bonus, particularly due to some tax benefits both for the employee and employer
• It allows an alignment between employees’ interests and interests of other shareholders
• It encourages the recruitment of talent, as it is an added benefit

Check our content on retention rate, employee motivation and talent management in the following articles:

• 9 Effective Employee Retention Strategies
• Employee Benefit Programmes: a guide to employee motivation
• What is talent management?

The cons

• The volatility in share prices has an impact on employee morale
• The administration of the scheme is not always straightforward and might involve some administrative costs
• The ownership of shares gets diluted, as there are more shareholders owning smaller percentages of the business
• It can generate a loss of control over decision making. To continue making all important decisions, the main shareholder needs to have 75% of the votes.
• It generates financial expectations from the shareholders

Employee share plans can bring huge benefits to the business, particularly when linked with tax advantages. The choice of scheme should depend on the size of the business and what the business wants to achieve through the plan.