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What impact does a merger or acquisition have on employee share plans?

Employee share schemes are popular components of benefits packages in both small and large businesses. Under these schemes, staff are offered the chance to become shareholders in the company for which they work, providing them with an incentive to help the business grow and rewarding them when it does via an increase in share value.

However, the existence of an employee share scheme can be a major issue when a merger or acquisition is on the cards. This is because potential purchasers will want to buy out any pre-existing employee share rights before the sale, and employees will want to be able to sell their shares alongside the target company’s existing shareholders as part of the deal.

In this guide, we take a closer look at this issue and explore the impact of M&A on existing company share schemes.

Due diligence issues and employee share schemes

If you’re thinking of buying a company that has a pre-existing employee share scheme, you’ll need to understand who the members are, and how it works. These details will be provided as part of the due diligence and disclosure processes.

For example, you’ll want to know what incentives there are under the scheme, how any share options operate, and what effect a potential company sale will have on these. 

Here are the kinds of questions you need to ask:

  • How many share awards or share options are there? In the case of options: how many will be exercisable? what is the exercise price? are any awards dependent on employee performance, and will the performance targets be met? When will options lapse?
  • Have any necessary HMRC notifications of option grant, scheme registrations and annual returns been made and are these up to date?
  • Are any tax advantaged share schemes still compliant with any HMRC requirements?
  • What do the plan rules say, and how would an M&A transaction affect share scheme beneficiaries? Normally a company sale would trigger the right for employees to exercise share options or entitle employee shareholders to sell their shares.
  • What will happen if all the employee shares are issued, and how much will employees pay for these shares?
  • How much PAYE income tax and employee/employer NICs will be payable?
  • Will a corporation tax deduction be available in the target company? Can it utilise it?

Mergers and acquisitions as a trigger event under employee share schemes

Normally, a company sale would mean that employees are entitled to exercise their share options or the right to acquire shares, as this is deemed a ‘trigger event’ under the plan rules. If existing options are not exercised they will normally lapse. However, employees may be offered replacement option awards or new shares under the deal.

Employee share schemes and the share purchase agreement

Details of employee share schemes will be included in the share purchase agreement, and the effect that these have on the company’s share capital factored into the transaction. The company’s seller will provide the buyer with warranties that confirm details about how it operates, and how the share capital of the seller may be diluted by any new shares issued pre-sale.

Employee share schemes and private company M&A

If you’re considering buying a private limited company that’s a successful business, there’ll most likely be a share scheme in operation such as an Enterprise Management Incentive scheme or ‘EMI’. Usually, these types of schemes offer key employees the chance to buy shares on the occurrence of an M&A transaction, and any outstanding vesting requirements are often accelerated so that all options become exercisable. Alternatively, incentive arrangements may consist of growth shares, where rewards are tied to the business achieving a certain amount of growth or increase in capital value.

Unlike purchases of public limited companies with employee share schemes, buyers of private companies will normally expect to acquire all the company’s shares on a fully diluted basis before or at the time of the sale. With public companies, there are legal mechanisms in place that make it relatively easy to acquire employee shares post-transaction but with private companies, things can be a bit more complicated.

This is because the Articles of Association of a private company may contain provisions called ‘drag along’ provisions that entitle majority shareholders to force minority shareholders such as employees to sell their shares as part of the deal. Because buyers don’t want to deal with the minutiae of share acquisition, it’s simply easier to ensure that all the shares be offered to them as part of the transaction. A buyer will want to check that any unexercised share options lapse on or immediately after completion of the transaction.

Employee share schemes and public company M&A

If you’re thinking of buying a public limited company that has an active employee share scheme, such as a CSOP, SAYE, SIP or a non-tax advantaged share plan, the Board will normally have discretion to determine whether unvested shares or share options will vest in the event of a takeover. If there are outstanding options, you’ll need to make an appropriate offer to all option holders or employee shareholders when you offer to buy the company and treat them the same as any other shareholder. Any further dilution of the share capital through the exercise of employee share options therefore needs to be taken into account when assessing the acquisition price.

Under the Takeover Code, the target company will be restricted in how many new shares or options can be granted to employees before the sale.

Communicating with employees

If you’re buying a quoted company, then the Takeover Code will regulate how you communicate with employees. It will be important that you follow the rules correctly so that you keep employees on side and comply with any HMRC requirements concerning the sale. The documents sent to employees will give the background to the deal and tell employees how it may affect them in terms of the rewards they’ll receive for shares and the tax treatment.

Private company sales will be less complicated, although you’ll need to let employees know when they can exercise share options, when those options will lapse, how they will be paid for the sale of their shares, and whether any consideration will be deferred.

Tax consequences

Because both income tax and National Insurance contributions (both employers’ and employees’ NIC contributions) may be payable in the event of a company sale and the vesting of shares or options, you’ll need to factor this into the overall cost of the transaction. Employer NICs will be a cost in the target company unless they can be transferred to employees and accounting for tax/NICS under PAYE should be factored into the transaction process.

A corporation tax deduction may be available in the target company, which may be an asset for that company to the extent the company can utilise it.

Setting up a replacement employee share scheme

If you’re planning to hold onto key employees post-transaction, you’ll need to consider what employee share scheme you’ll offer them to keep them onboard and ensure that you can attract recruits to the business. The team at Harper James can walk you through the options to help you determine what share option scheme is right for you.

For more answers to commonly asked questions and company acquisition advice, read our Mergers and Acquisitions FAQs.

About our expert

Adam Kudryl

Adam Kudryl

Chief Legal Officer & Head of Corporate
Having qualified as a solicitor in 2003, Adam has over 20 years' experience in advising businesses on their growth and exit strategies. Adam joined Harper James as a Partner in 2018 and became Head of Corporate in 2022. As of April 2024, Adam’s new role is Chief Legal Officer & Head of Corporate. In this role, he is responsible for the legal services aspects of Harper James and for defining the firm’s strategic vision and objectives to achieve our long-term goals, together with our CEO, Toby Harper, and the other senior leaders.

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