Employee Ownership - A comparison of 'direct' and 'indirect' share ownership

This article considers the options for holding shares in an EO company and considers the pros and cons for both 'direct' and 'indirect' ownership.

Background

Employee Owned companies have a variety of ownership structures as follows:  

The final structure of an employee owned company may often depend on the aims and aspirations of the initial owners.  Typical considerations for the owners include:

• Are they looking to sell the company for full market value? 
• Are they willing to gift some or all of the company to an Employee Benefit Trust? 
• Do they wish to be paid immediately? 
• Are they willing to sell the company over a period of years?  
• Should the managers/employees be incentivised through shares?

In this article, we consider some of the advantages and disadvantages of both direct and indirect share ownership.

Direct share ownership

As the name suggests, direct share ownership is when a business owner sells his or her shares in the company to the employees, who in turn hold the shares in their own names.

The main reason which is given for direct share ownership is that it is an effective way to ensure that an employee's interests are aligned with those of the business.  If an employee buys shares in the employee owned company; he or she will benefit if the company succeeds.

There can be other reasons why direct share ownership occurs; for example:

• Management or other employees own shares before the succession to employee ownership and, for example, the Employee Benefit Trust cannot afford to buy out all those shares on day one.
• There is a need for retiring owners to retain some shares because the employees cannot afford to purchase their whole shareholding in one go.
• Capital is needed to bridge a purchase price gap and therefore employees are invited to buy shares through a tax efficient employee share incentive plan to make up the difference.

Indirect share ownership

Indirect share ownership involves a trust, set up by the company, to hold shares on the employees' behalf.

There are two types of trust used by employee owned companies: an Employee Benefit Trust (EBT) or an Employee Ownership Trust (EOT).

There are a range of reasons why indirect share ownership can be a valid option. For example:

• Employee motivation can be achieved through employee engagement and cash bonuses.
• EO companies that operate a direct share ownership policy can sometimes be burdened by the obligation to use reserves to buy shares from departing employees whereas indirectly owned businesses can re-invest profits in the business.
• Buying shares in the business directly is motivating for employees when the business goes well but less so when the business is doing less well and the shares decline in value - the business pays no dividends and there is no market for the shares.
• Is there a greater danger of employees selling the business if they own it individually through share ownership than when the shares are held in an Employee Benefit Trust?
• There may be tax incentives for a seller of the business to an Employee Ownership Trust. If a business is 51% owned by an Employee Ownership Trust, the business can pay certain bonuses free of income tax.  

Other things to consider 

• If there is direct share ownership should it be as wide as possible amongst employees?
• Should there be a limit on the percentage of shares in the hands of employees in order to reduce problems arising from employees seeking to sell shares and finding no buyers among employees, the company or the EBT?
• Should employees purchase shares rather than be given them by the company?
• Should there be a limit on the percentage of shares held by any one individual?
• Is there an employee ownership investment fund which might invest in the EBT or in the company to provide long term support for employee ownership?

More information about Employee Ownership can be found here.