Indirect vs direct employee ownership

The Employee Ownership Association recently reported that, as of December 2022, there are over 1,300 employee-owned businesses operating in the UK.

The employee-owned sector is growing at a rapid rate as more and more businesses discover the benefits employee ownership can bring to businesses, their existing owners, and their employees. There are, however, different types of employee ownership: direct and indirect. In this guide, we will explain the key differences between them.

The difference between direct and indirect employee ownership

• Direct employee ownership means employees own shares in a company directly. In other words, the employees are individual shareholders in the company and have a direct ownership interest. This could mean the company offers employees new shares or share options, or employees may purchase shares directly from existing shareholders.
• Indirect employee ownership, by contrast, means employees own shares in a company through a collective investment vehicle, such as a trust or a pension fund, rather than owning these shares directly.

The benefits of direct employee ownership

Direct employee ownership gives involved employees a stronger sense of ownership and engagement with the company, as they have a direct stake in the company’s long-term success and have an opportunity to participate in dividends. It can also help align company and employee interests and boost employee retention.

Example: Growth Shares

Growth shares allow employees to partake in a company's success by sharing in its value when specific milestones are achieved. They align interests, motivate employees, and provide a tangible way to benefit from company growth.

The initial value of growth shares is generally low, which enables employees to acquire them with reduced economic risk. These shares then gain in value once they pass a specific valuation threshold. Employees can then enjoy a share in the company’s value above that threshold.

Growth shares are generally forfeited if the employee leaves the company (except in specific circumstances). The employer can set conditions for employees to retain their growth shares, which can encourage them to stay committed and contribute to the company's ongoing success.

The benefits of indirect employee ownership

The principal benefits of indirect employee ownership, such as through an EOT model, are broadly similar to those of the direct route outlined above.

In addition to these, however, it brings other unique benefits including:

• Broader participation and greater accessibility for employees
• Greater flexibility in structuring ownership
• It may be more cost-effective for the company, as they won’t need to issue individual shares to employees or establish a share scheme. The company can simply contribute to a trust or investment fund on behalf of its employees
• A collective investment vehicle can reduce the administrative burden on the company, as they do not need to issue and manage individual employee shares.

Example: Employee Ownership Trust (EOT)

An Employee Ownership Trust (EOT) is a model of indirect employee ownership, where a trust is set up by the existing owner for the benefit of all employees. This trust then becomes the majority owner of the business as part of an exit or succession planning strategy.

Since its introduction in 2014, an EOT has become the most popular indirect employee ownership model, and for good reason.

In addition to the benefits listed above, the EOT model brings further benefits, including:

• Tax-free bonuses of up to £3,600 for employees, subject to qualifying criteria
• Guaranteed market value for the shares being sold, subject to independent valuation
• Exiting shareholders gain certainty of exit in a clearly defined time frame.
• Succession can be implemented over time – departing owners may retain a level of involvement to ensure the transition period is smooth.
• It is a good option for shareholders who want to preserve their legacy as business owners.

It should be noted that EOT is principally used as an exit strategy; that is when a business owner sells their controlling stake in a company to retire or pursue other ventures.

What is a hybrid employee ownership model?

It is possible for a company to participate in both direct and indirect employee ownership at the same time. This is often known as a hybrid model.

An example of a hybrid model could be a company that is majority owned by an EOT (therefore indirectly owned by all of the employees) that also has a direct share scheme in place. This allows the company to provide additional targeted incentives for key employees such as the senior leadership team.

It’s important to seek advice when planning

Both direct and indirect employee ownership models can be complex to set up, and a wide range of considerations must be made before, during and after the process takes place. We recommend speaking to a member of our Corporate Finance team about your requirements so that we can help you fully understand your position and available options.