Free shares act as an employment benefit which can be used widely but are often given to senior management as a reward for meeting certain metrics. For example, building their team up to £1m profit will mean they receive x amount of free shares.

One of the many challenges that businesses face is retaining key members of staff. Increased salary and bonuses can only do so much and may not always work for the company cashflow.

Issuing free shares (or alternative share options) to employees can work as a strategic response to cashflow restraints and recruitment challenges.

How do Free Shares Work?

When free shares are issued, the employee receives no cash, but they are treated as a non-cash payment equal to the market value of those shares. Whatever the value of shares stands at, it will be subject to income tax for the employee and employer’s national insurance from the company.

It is possible for the employee to be charged employee’s NI in some circumstances too, but this is rare for SMEs. In this instance, the fact the employee receives no cash on these free shares and then has a tax bill, means they receive a “dry tax charge”, which means the larger the value of shares, the worse of a position the employee is put into.

Why Companies Might Issue Free Shares:

As a business, some of the benefits to giving your employee’s shares might include:

Changing Employee Mindset

When an employee receives shares, their mindset shifts from that of an employee (thinking “what is my salary?”) to a shareholder, where they are interested in company profitability, company valuation, and any non-business risks. This is because they now share in the rewards of any future profits of the company and/or any future exit of the business.

This can be largely beneficial for a business who wish to use this as a tool to hire staff who will be influential, especially in cases where the company cannot stomach the salary.

For example, if a tech start-up wanted to recruit a highly influential employee wanting a £200k salary but they could only pay £125k, they might give them a 25% stake in the business to compete with established businesses.

This would mean that if the company came to sell in 10 years and was successful, the employee would receive £25m of the proceeds. If the shares are given to the employee early enough, the value of the free shares should be much lower so the tax bill should be far lower than giving free shares after the business has reached it’s peak valuation.

Ensuring Employee Comfort

A company owner might want to sell in 15-20 years’ time, but their preference may be to sell to the up-and-coming management team. Sometimes, it’s hard to get the management team to want to buy in as they don’t see the benefit, understand the value or want to commit. Therefore, a more realistic benefit for businesses that aren’t multi-billion would be employee engagement.

Giving shares to staff well in advance of sales means that they can confirm that the recipient is comfortable with the switch from employee to shareholder. This can lead to the employee having the option to be part of a team to buyout the owner in the future when the company reaches a predetermined value. This benefits both the employee and employer by preventing the need to market externally.

This is particularly useful as marketing a company may take years, sales can fall through and the business might not succeed post sale, so a buyout by management can be a great plan.

In instances where management don’t buyout the majority shareholder, a buyer would still often prefer a motivated management team so a few senior managers holding 5% each for example, would provide a huge advantage for a buyer as they know the management team will have the same interests as they do. This could lead to getting a better sale price or potentially get a sale agreed much faster due to competing buyers.

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For a business, issuing free shares to employees, this can be a great way to not only combat recruitment challenges and financial constraints, but also give employees incentive and reassurance.

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 If you’re interested in learning more about how issuing free shares can help your business, get in touch.

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