Incentive arrangements to help keep and attract staff in a UK downturn

The prospect of a serious economic downturn is a concern for all businesses, and companies providing workforce solutions are likely to be particularly affected by hiring freezes and reduced revenues. And the general impact of a UK downturn on some players in the workforce solutions sector could be broad. 

Holding onto key staff, who may become unsettled, is one key challenge in these economic conditions, and there are many different types of equity arrangements and structures available to workforce solutions companies.

Recruitment and retention tool  

Employee share plans are a valuable recruitment and retention tool. If revenues are taking a hit and the business has less cash than in better times, many types of remuneration scheme (including commission arrangements and bonuses) can be unaffordable or unattractive. The lesson of previous downturns is that, if commission schemes become less attractive, employees in the sector may start to look elsewhere or think about setting up their own business.  

Clearly, in an industry that has suffered its own talent shortages for some time, it is important for businesses to retain key staff (and attract new talent). Equity incentives can be used both as a hiring tool and as a cost-effective way to retain and motivate employees. 

In the current economic climate, many founders and business owners will be feeling that they would like a tax effective way of incentivising their staff without it "costing" anything. Share plans can deliver the motivational impact required, while minimising the cost implications of the incentive (which can severely impact workforce solutions companies).  

Share options give the employee a right to acquire shares at a fixed price and on a future date (or dates). In the UK, that future date is typically on the occurrence of a liquidity event such as a share sale or (perhaps less likely for the moment) initial public offering. Vesting and performance conditions can be specified on grant, which can be designed to reflect the company's overall strategy or specific individual objectives to be met.

The EMI option

Enterprise management incentive (EMI) options are the most tax-efficient arrangement for companies and employees and were left untouched in the recent budget. For all tax-advantaged arrangements, it is important to check qualification prior to the grant of options and during the life of the plan. 

Broadly, smaller independent trading companies with gross assets of less than £30 million may potentially qualify for EMI. 

Qualifying companies are able to grant EMI options over shares with a market value of up to £250,000 (valued at the date of grant) to eligible employees. To qualify, the employees must satisfy a working-time requirement (working 25 hours a week or, if less, 75% of working time for the company or its group).  

The growth in value of the shares (above the market value on grant) in the period from grant to exercise may be taxed as capital not income. The tax efficiencies affect not only the employee but also the employing company, which can benefit from employer's National Insurance contributions (NICs) savings that are not available for cash reward packages.

CSOP and non-tax-advantaged options

If a company does not qualify or has grown too big for EMI, then the more traditional Company Share Option Plan (CSOP) may be a possibility (particularly after 6 April 2023 when relaxations on which companies qualify are due to be introduced, along with doubling the individual limit to £60,000 per employee).  

Otherwise, non-tax advantaged options may be granted. Under this route, income tax will be payable on the gains arising on exercise (typically together with employer's and employee's NICs, such taxes and social security contributions to be accounted for by the employer to HMRC through the PAYE payroll system). 

Growth shares

As an alternative to tax-advantaged EMI and CSOP, another arrangement which may offer capital treatment would be to issue key employees with a new class of shares (often referred to as growth shares). This approach has been very common among staffing and recruitment companies in the last few years.

These could be shares of relatively low value, which only give rise to capital value over and above that of the company currently (typically, plus a hurdle). Much will depend on the valuation of the company, and the documentation would typically include special terms relating to the shares, which would mean that employees would forfeit them should they leave or if certain performance targets are not achieved.  

Employee ownership trusts

In terms of exit strategy, there is continuing interest among staffing and recruitment companies in the establishment of employee ownership trusts (EOTs) and transactions involving EOTs, and we have advised staffing and recruitment companies on a lot of these in the last two years.

An EOT is a special type of employee benefit trust that allows a company to become employee owned.  Under this route, shareholders (such as founder shareholders) can sell the shares in their company to an EOT for the benefit of employees - enabling them to realise value while ensuring that the culture and ethos remains, and without losing control to a private equity company or other external shareholder. To encourage indirect employee ownership, generous tax reliefs are potentially available for both the selling shareholders and the employees (provided the legislative requirements are met).   

Osborne Clarke comment

In determining which structure is appropriate, factors such as the business objectives, valuation and due diligence (to consider whether tax relief is likely to be available) will be key. Companies operating employment-related security arrangements need to comply with important requirements to register their arrangements online with HMRC and submit annual returns. In the case of tax-advantaged plans, there are additional notification and self-certification requirements.

And, of course, the introduction of an incentive arrangement is the perfect time to tighten up (on a carrot and stick basis) employment terms with key staff including – given the inevitability of departures and potential attempts to take clients and candidates – restrictive covenants and social media policies ensuring employer ownership of social media contacts made by the employee for business purposes.

How can Osborne Clarke help? At Osborne Clarke we have a dedicated team of incentives lawyers who have a wealth of experience in the design and implementation of share incentives for a wide variety of companies (including those in the workforce solutions sector), both in the UK and internationally. 

For more information, please contact your usual Osborne Clarke contact or one of the experts listed below.