The Department for Business Innovation & Skills (BIS) has launched a consultation on creating a new employment status known as an “employee owner”.

Under the proposals, employers will be able to take on employees with reduced rights in return for those individuals being "given" shares in their employing company which, on sale, would be exempt from capital gains tax.

The details set out in the consultation are still rather sketchy. However, as managers in a typical private equity structure are typically both employees and shareholders, these proposals may well impact upon them.

The Proposals

The Government proposes to create a new category of employee, the ‘employee owner’, which will have the following characteristics:

  • limited employment rights - employee owners will be entitled to a more limited set of employment rights than a traditional employee;  
  • the employee being ‘given’ an equity stake in their employer - an employee owner would be “given” between £2,000 and £50,000 worth of shares in their employing company; and  
  • entitlement to favourable tax treatment on the sale of shares - any gains on the sale of the shares held by an employee owner would be exempt from CGT.

Employee Owner - FAQs

  1. When will this happen? BIS estimates that legislation implementing the proposals will be passed in April 2013.  
  2. What rights will employee owners give up? Employee owners will not be entitled to (i) protection against unfair dismissal (except where it is automatically unfair or relates to anti-discrimination law), (ii) certain rights to request flexible working and training, (iii) statutory redundancy pay, and (iv) will have to give longer notice of their intent to return from maternity or adoption leave (16 weeks as opposed to the current 8 weeks).  
  3. Can a company offer an employee owner more generous rights? This is a possibility. The consultation document does not rule out the possibility of employers requiring the new status (thus securing favourable tax treatment for the employee) and still offering more employment protections contractually.  
  4. Can any company choose to use employee owner status? Yes. Companies of any size will be able to use this new status although clearly the proposals may be of particular interest to companies and employees where there is the intention of significant share price growth, for example private equity investee companies.  
  5. What type of shares can be given to employees? The consultation notes that all types of shares will be eligible under these arrangement, including shares which carry rights to dividends, voting rights, or on a return of capital.  
  6. Can the usual forfeiture restrictions be applied to the shares? In part. BIS note that employers would likely wish to apply restrictions on the shares that they issue and would be allowed to include a requirement that the employee gives up their shares on cessation of employment. However, this is subject to the requirement that the shares are brought back at a "reasonable value".  
  7. Will there be any other requirements? The only further requirement that BIS has suggested is for employers to properly explain to potential “employee owners” the implications of agreeing to be employed on this basis.  
  8. Do the usual income tax and NICs rules for shares acquired by reason of employment continue to apply? Yes, this will apply in the normal way. The shares are also not expected to be eligible for the Enterprise Incentive Scheme or any tax-advantaged employee share scheme.

Key Questions for Private Equity

It is probably a little early to judge the potential impact and implications of the new ‘employee owner’ status. For private equity investors, the following questions (amongst others) are still to be addressed:

  1. Sweet equity - if management ‘sweet equity’ is covered by the future legislation then private equity investors may be given an opportunity to allow their management teams to benefit from a significant CGT benefit over the existing Entrepreneurs Relief regime. Not only would it mean that potentially no CGT is payable rather than 10 per cent., but there is no requirement for employees have a minimum 5 per cent. shareholding.  
  2. Group arrangements- at present, the consultation states that shares “given” to employees must be in the capital of the entity which employs them. Whilst in a private equity structure the top company in the group may be both the employer of the management team and the entity which will be realised for value, this is not always the case. Consideration will need to be given as to whether an employee can be given shares in a different group company to the one that is the employer.  
  3. Leaver provisions and buying back at a “reasonable value” - as noted above, the consultation assumes that employers will be able to force a sale of the shares held by an employee on their cessation of employment provided that this is done at a “reasonable value”. BIS has not given a view on what this value should be based upon and whether the circumstances in which an employee is dismissed should have any bearing on that value. Depending on the answer to this question, private equity houses will need to consider whether standard ‘leaver’ provisions need to be adapted.  
  4. Share restrictions - although the consultation does not suggest that there will be any restrictions on the rights attaching to the shares given to employees, private equity investors will want to be sure that standard provisions such as drag along, disenfranchisement and so on will be capable of applying to the shares.

We are awaiting the result of the consultation with interest. If the new proposals do apply to managers in private equity structures then this is likely to have a significant impact on how these arrangements are structured.