Retention incentives include offering shares in the business

There has been an increase in the number of small businesses offering their employees share incentives, to retain their loyalty to the business. How does this work?

Providing share incentives is a way to help retain employees who have the skills to help drive growth and success. This type of incentive can build morale in a business and make individual employees understand that there are direct rewards for contributing towards their company’s success.

If an employee receives shares in a company, they will become a shareholder in it. Depending on what rights attach to those shares, the employee could then share in the profits of the company and/or take part in voting in shareholders’ meetings.

Registered companies must adopt governing rules, such as articles of association. Many companies also have a shareholders’ agreement in place. Both documents can be used to regulate the relationship between the employee shareholders and other company shareholders. One matter that the shareholders’ agreement and the articles of association should deal with is the situation when an employee leaves your company. What happens to those shares when the employee leaves – who can buy them and for what price?

What is often seen in the shareholders’ agreement is that the existing shareholders have the first option to buy the departing employee’s shares, rather than allowing the employee to transfer their shares to a third party. In addition, the documents often include the concept of a ‘good leaver’ or a ‘bad leaver’ and depending on the circumstances of the departure will determine the way that the shares are dealt with.

In terms of the price to be paid for those shares, a departing employee who is a good leaver may be entitled to receive fair market value for his shares, whereas a bad leaver may only receive nominal value for his shares. This means it is imperative that any business owner considering “sharing” the business, should take robust legal advice before proceeding!