Incentivising employees

In the second article in our series, Employee Ownership Trusts: Looking to the Future, the TLT Employee Ownership team discusses how employee-owned companies can incentivise employees post-transition and looks at the different reward structures that can be used.

Why would an employee-owned (EO) company wish to incentivise employees over and above the employee ownership trust (EOT) profit sharing scheme?

An employee-owned company is usually a trading company (or the parent company of a trading group) where the controlling interest in that company is owned by an EOT. The trustee(s) of the EOT will hold the shares in the trading company on the terms of the trust for the employees of the company, who are the beneficiaries of the trust. As and when profits are made by the company, those profits are shared with the beneficiaries, through a bonus-based profit sharing scheme.

Whilst the profit share can be differentiated between the employees based on hours worked, length of service or remuneration, EO companies may also wish to put in place reward or performance structures for key staff, or allow all staff to acquire actual shares in the company.

This is for a number of reasons. Performance or reward structures are often seen as necessary to recruit talent into EO companies (and to come closer to matching the reward structures desired key individuals may be benefitting from at their current employers). When in post, EO companies may also want to reward performance over and above the differentiation allowed through the EOT profit sharing scheme. EO companies may also see an attraction in allowing staff to buy actual shares so as to build their own share portfolio (outside of the indirect interests an employee has through the EOT), which they may see as increasing employee motivation and further entrenching the employee ownership ethos. This may also have the knock-on benefit of allowing employees to add to their retirement fund.

A balance is, of course, required. One of the significant advantages of an EOT is that all employees benefit broadly on the same terms and share equally in the successes and failures of the EO company. Introducing discretionary benefits for certain key individuals can create a divide.

What reward structures are available?

Often EO companies will use discretionary bonus schemes which allow them to reward selected employees for high or exceptional performance or completion of significant projects.

Companies might also use share-based schemes such as Enterprise Management Incentives (EMI) or Company Share Option Plans to give selected employees options over shares. Under these options, employees have the right to acquire shares at a point in the future, for a price fixed at the date of grant of the options. Those employees, provided they remain in employment, can then choose to exercise those options later, when they are comfortable the underlying shares have risen in value.

Where an EO company wants to extend actual share ownership to all employees, a Share Incentive Plan (SIP) can be used, under which free shares can be awarded or employees can be allowed to buy shares on preferential terms. A SIP has a number of similarities with an EOT in that awards under a SIP must be offered to all employees and the only differentiation allowed is on the basis of hours worked, length of service or remuneration. It can work very effectively alongside an EOT allowing employees to build up a valuable direct holding of shares.

Do these arrangements conflict with the all-employee ethos that underpins employee-owned companies?

This is a key point. Often, the trustees of the EOT will have agreed a number of reserved matters when the company moved to employee ownership. Those are likely to include the adoption of discretionary reward structures (whether they be cash or equity based) and the issue or transfer of any actual shares to employees.

Trustees will need to consider whether the introduction of discretionary reward structures are in the best interests of the employees, being the beneficial class of the EOT. If the reward structures are intended to drive increased performance or efficiency in the business, implementation of those arrangements may well be considered to be in the best interests of all employees, because improved profitability will benefit all employees.

Considerations will be different around any proposal to implement all-employee direct share arrangements, such as a SIP. The beneficial class of a SIP and an EOT are, effectively, aligned so the decision for the trustees is likely to focus more on a cost/benefit analysis of direct share ownership i.e. the benefits to employees of holding actual shares against the costs to the business of implementation and the administration burden that direct share ownership brings.

An important point to note is that the trustees’ decision may be made easier if, on transition to employee ownership, the original founders are clear whether they support equity-based plans or direct share ownership or would prefer the model to remain indirect. In a number of cases, where a hybrid model of indirect and direct ownership is the founders’ intention, expectations and parameters have been made clear to the trustees in the transition legal documentation.

Are there any other considerations to take into account?

A number of the equity-based plans referred to above are government sponsored and, like the EOT itself, confer material tax advantages on employees. Although never a reason to implement them alone, if employees holding shares directly is something the original founders and trustees want to encourage, that combined with the tax advantages of such arrangements can give EO companies a significant commercial advantage in attracting and retaining talent.

Care is needed to understand all of the tax implications, however, including whether the trading company will be eligible for corporation tax relief in respect of the discretionary reward structures or all-employee share schemes.

Liquidity and valuation are also significant considerations. Due to an EOT, typically, using a deferred payment structure to buy-out the original founders, the equity value of an EO business can look materially different immediately after transition to its value before. Often, this is a good opportunity to put in place equity-based incentives under EMI to key individuals which will only vest once the buy-out period has completed.

If direct shares are to be used, an internal market will be needed, at an appropriate time in future, to give liquidity to the shares that the employees have acquired. How that internal market works and at what price shares can be bought and sold needs careful consideration and planning.

TLT comment

The EO model is ever evolving and developing and covers an increasingly diverse range of businesses and sectors.

Use of tailored reward structures to attract and retain talent will remain important for EO businesses, just as it is for others – and in the EO world can be used to complement the underlying model of employee ownership.

In determining which reward structures are right for them or whether a hybrid model of employee ownership is right for them, EO companies will need to weigh up the pros and cons carefully.

A number of our clients have developed models which achieve the right balance and add additional value to their employee ownership structures and ambitions.

How can we help?

TLT has been a leading firm active in the employee ownership sector for a number of years. Our specialist, and experienced, employee ownership lawyers have a diverse range of clients in England, Wales, Northern Ireland and Scotland.

We provide insightful strategic direction to employee-owned businesses at every stage of their journey and have led a number of the most high-profile employee ownership transactions within the UK.

If you are interested in discussing any of the topics covered in this article, get in touch with our employee ownership specialists below.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at February 2025. Specific advice should be sought for specific cases. For more information see our terms & conditions.