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We hear plenty of talk from government about the need to stimulate private enterprise, destroy bureaucracy and removing the need for unnecessary paperwork.  You would have thought, therefore, that something which is at the very heart of private enterprise, like issuing shares to employees and directors, should be dead simple.  The reality is that it isn’t and there are plenty of traps for the unwary. 

On top of this, issuing shares to employees is one of those things that often sounds a great idea in theory but when looked at in more detail doesn’t always stand up to scrutiny.  We’ve looked before at some of the considerations.   

The aim of this blog is to look at bit more of the detail and the specific points to watch for.  A number of these are tax related so we have had the input of Corrigan and Associates in putting this blog together.  They are a firm of accountants and tax advisors who specialise in advising young entrepreneurial businesses, you can find out more about them here.

If you issue shares for less than their market value watch out for income tax and national insurance: if shares are issued to employees or directors for less than their market value then the employee may be liable to pay income tax on the difference between the price paid and the market value and the employee and the company may be liable to pay national insurance.

You can’t give the shares away:  with companies incorporated in England and Wales their shares all have a nominal value (this could be anything, but £1 or a penny are common values) and with very few exceptions this nominal value must always be paid as a minimum.  In many cases the market value of the shares is higher than this nominal value. In this case you may want the employees to pay a higher price. This is fine – what you can’t do is let them pay less than the nominal value for their shares.

Get the formalities right: the new Companies Act was meant to make routine things like issuing shares a lot easier.  For some companies (in particular, if they were incorporated after 1st October 2009) this is the case but there are plenty of caveats and exceptions.  So get whatever advice you need to make sure the formalities are complied with, don’t wing it:

  • always make sure the allotment is approved at a board meeting and keep minutes of the meeting
  • you may well need to pass a shareholder resolution to authorise the allotment.  Whether or not this is the case will vary from situation to situation so this is where there is a need for advice

Be aware of what you need to file: once you issue the shares you will need to carry out a few admin tasks:

  • updating the company’s statutory books
  • filling a return at Companies House (likely to be a form SH01 – you can download a copy here)
  • completing a form 42. A form 42 should be completed for each tax year in which shares are issued to employees or directors by virtue of their employment, either by way of direct transfer or by way of unapproved share options. The form should be filed by 7 July following the tax year end. The form 42 and some guidance can be found here.

Find out what a form 431 election is:  we are getting into fairly complex tax issues here and the detail is beyond the scope of this blog. Our good friends at HMRC are always on the look out to ensure that people are paying enough income tax and aren’t issuing shares as a way to avoid this.  So there is a complex web of tax legislation which aims to prevent this.  Maybe this is fine in theory but the complexity of the legislation coupled with the law of unintended consequences means that even normal, plain vanilla issues of shares to employees at market value can give rise to potential issues. I came across a good article here which gives the detail ….. see what we mean about complex.

Think about what should happen if employees leave: it is not ideal for ex-employees to continue to hold shares:

  • one of the reasons for allowing employees to hold shares is to encourage loyalty, if they’ve left this probably hasn’t worked
  •  if someone has left then he is not contributing to the future growth of the business, therefore is it right that they benefit from any increase in value?
  •  you may want to make the shares available to incentivise the remaining or new members of the team.

Unless there are some specific provisions in a shareholders’ agreement or the company’s articles (i.e. its constitution), once shares are issued there is no way to force an employee to sell his shares if he ceases to be an employee. It is definitely worth considering whether the company should include these provisions (commonly referred to as leaver provisions) in a shareholders agreement or its constitution.

Think about the need for a shareholders agreement and the articles: leaver provisions are a key thing to consider but there are other specific provisions to include in shareholders agreements and your company’s articles. These include:

  • drag along rights –  if the majority of shareholders want to sell the company then a drag along right enables the majority to force the minority to sell too (you wouldn’t want an employee who held a small percentage of shares to be able to block the sale of the company)
  • pre-emption rights – this prevents a shareholder from selling his shares without  first offering them to the other shareholders (you wouldn’t want an employee transferring his shares to someone you weren’t happy with)
  • making sure that by issuing shares to employees you haven’t given an employee or an individual a disproportionate amount of influence or the ability to block decisions