Employee share purchases can be offered to reward high performing employees, encourage loyalty, put in place a succession plan, or as a form of equity crowdfunding.
While they can be beneficial to both parties, generally the terms will be drafted to favour the employer’s interests because it is the employer who controls the process. This article briefly considers the key considerations for an employee before entering into this type of agreement.
Information about the company
The Financial Markets Conduct Act sets out what types of information an investor is entitled to receive by law. Employee share purchases of less than 10% of the entity can be exempt from the full disclosure requirements, with certain conditions attached (1).
However, at a minimum you are entitled to the latest annual report of the company, relevant financial statements and confirmation of whether they have been audited. You can ask for financial statements for earlier years if you want to get more information about the company’s performance over time, and you can ask if forecasts have been prepared. Check to ensure that the statements are for all of the entities you are buying into (if there are multiple).
The method for valuing the shares should be transparent and should make sense for the type of business you are buying into. If the company’s accountant values the shares this is not independent, so you may want to get independent accounting advice about the share value.
Funding of purchase
The shares can be purchased outright if you have funds. Sometimes, the seller (usually the business owner) might offer you a loan and require you to pay back the loan over time from your dividends. It is important to note that the company directors declare dividends and a minority shareholder does not have control over this. Their decision will affect how long it takes you to pay back the loan. A dividends policy can help to give you more certainty around this.
Before entering a loan agreement, you may want to consider your obligations to the lender:
What are the repayment terms if you exit the company without fully repaying the loan? The agreement with the seller may allow you to sell your shares back to them, either at the original purchase price or based on the original valuation method. This would enable you to repay the loan by selling the shares back. If there is no requirement for the seller to buy the shares back at all, or at a particular price, then you may be required to pay them the loan at short notice.
What happens if the company you are buying into becomes insolvent and you stop paying the loan to the lender? This can be addressed with a clause in the loan to provide that if the company goes into liquidation and the shareholders receive no funds, then the loan does not need to be repaid.
Minority shareholder rights and responsibilities
Your rights as a shareholder are set out in Part 7 of the Companies Act 1993, plus the company’s constitution and shareholders’ agreement (if any).
The majority shareholders (75% and over) have significant ability to control the company and can approve major transactions, alter the constitution and place the company into liquidation.
Minority shareholders can attend shareholder meetings, cast a vote in proportion to their shareholding, and request financial statements from the company. There are also minority buy out rights in the Companies Act which allow dissenting minority shareholders to require the company to buy their shares in some cases.
Shareholders are separate to the directors, and they are generally not liable for decisions made by the company, unless expressly stated (2).
Dividends
A dividends policy determines how much money you will receive (if any) from your shares each year. It should be contained in the shareholder agreement or constitution, noting that the majority shareholders can change the constitution. You may want to apply all of your dividends to the loan, or you may want to apply a proportion and have the rest paid out to you.
Restraints of trade
Typically, a share purchase can involve one or more of the below:
a non-compete clause (prohibiting you from working for a competitor company)
a non-solicitation clause (prohibiting you from ‘poaching’ clients or employees after you leave)
A conflict of interest clause (prohibiting you from owning shares in a competing company).
These are designed to protect the company’s commercial interests. A restraint of trade must be reasonable in scope and duration to be enforceable. It is worth getting advice on whether the restraint you are agreeing to is reasonable. You should also check whether the restraint will remain even if you are made redundant or terminated for performance or conduct reasons. Note that you may already have restraints of trade in your employment agreement.
Exiting the company
Generally, your exit as an employee will trigger the sale of your shares. Make sure the shareholder’s agreement clearly sets out the process if you exit the company. You may be required to offer your shares back to the seller or other existing shareholders, in which case you cannot sell them ‘on the market’ like you can with other shares. Check the mechanism for determining the price, which should be fair and ideally no less than what the shares were initially valued at. Also check that the loan terms and sale of shares will line up: for example, you may not want to be paying back the loan immediately but only receiving money from your share sale in 6 months’ time.
The shareholder agreement should also contain ‘tag along’ and ‘drag along’ provisions which apply in the event of the majority shareholder selling their shares. These are in addition to the minority shareholder buy out rights contained in the Companies Act.
Other matters
While not covered in this summary, other things you should consider are:
How you want to own the shares
The contents of the constitution and shareholder agreement, particularly any additional rights and protections they give you as a minority shareholder
Tax implications (if any).
Conclusion
A share purchase which does not require you to put in any funds may seem like a ‘no brainer’ at first glance. However, it is worthwhile pausing to consider what might happen if you eventually leave the company. Having professional advice may help you to fine tune the agreement to protect yourself against unforeseen events.
Disclaimer: This article is a general overview only and not a substitute for legal advice specific to your circumstances.
(1) See sections 5-10 of the Financial Markets Conduct (Employee Share Purchase Schemes) Exemption Notice 2021
(2) Note however that there are certain responsibilities under the Health and Safety Work Act which can apply to senior managers, even if they are not company directors.
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