Legal

Helping employees to share in your profits

4 Nov 2019 By Katharine Mortimer

The recent BA strike hinges on how employees can benefit from financial success. Katherine Mortimer explains the options for employers

Before the recent strikes by British Airways (BA) employees, the airline offered staff a "fair and generous" pay increase worth 11.5 per cent over three years. This was rejected, with the union suggesting that its members deserved better in the light of BA's recent profits. Whatever your view on the relative merits of the opposing parties, failure to find a settlement will, in the short term, slice an estimated £100m from BA’s profits, purely from the direct loss of revenue and extra costs from the first two-day strike.

Speak to any chief executive and they are likely to say that recruitment and retention of staff is one of their most difficult challenges.

For businesses that want their employees to share in their success, there are established routes to do so. For our clients, one of the first questions we ask is whether the board wishes its employees to share in current income, or whether the intention is for the company to invest and grow and for key – or indeed all – employees to share in that capital growth, for example, on exit.

If the intention is for the company to give staff the right to share in current income, there are broadly two options:

  • A contractual profit sharing/bonus arrangement. Schemes linked to share price are commonly referred to as phantom share option agreements. In the case of a private company where shares are notoriously difficult to value, the reference point tends to be EBITDA or similar. In the employee’s hands this would be subject to income tax and national insurance in the usual way;
  • Alternatively, the company can issue shares or options over shares that are capable of exercise over time or if certain pre-agreed criteria are met. Once an employee has become a shareholder or member of the company, they can be paid a dividend and can therefore share in current profitability. Unlike a salary, there is no entitlement to a dividend. It will always be subject to there being sufficient distributable profits and to the board making the appropriate recommendation. 

If the intention is to reward employees for their commitment and to give them a share in capital growth to which they have contributed, an EMI scheme is a straightforward tax-efficient route to do so. On 18 June 2018, HMRC published a report evaluating the impact of EMI on small and medium-sized enterprises. The report concluded that there was substantial evidence that the EMI scheme is fulfilling its core aim of improving recruitment and retention prospects for small and medium enterprises and supporting their future growth.

In summary, the company grants to the employee a right to acquire a fixed number of shares at a future point at a price that is equal to the current market value. For ‘exit only’ options, the intention is for the employee to exercise this option and acquire shares and then immediately sell them on to the third-party offeror. Capital gains tax (subject to the availability of any applicable relief) rather than income tax is then payable on the difference between the exercise price and the sale price. The employee shares in the uplift in value without the company having to deal with the administrative issues that can arise with a large number of employee shareholders.

To qualify to grant an EMI, the company must satisfy several conditions. These include that the company is an independent trading company, it has gross assets of no more than £30m and fewer than the equivalent of 250 full-time employees. To be eligible for an EMI option, an employee must work for the company for at least 25 hours per week or at least 75 per cent of their working time.

Katharine Mortimer is a partner in the corporate team at Royds Withy King

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