So we have given everybody a raft of reasons why issuing shares to staff in your family business is a bad idea. However, the simple fact remains that many people do issue shares and it works spectacularly well.
So why do people issue shares to their staff?
Quite often the great staff in the team will want a share of the business. No other variation can be put on the table.
The desire for ownership need not only be financial. Often the employee has committed their life to the business and they feel like they are part of the business forever.
For these people nothing other than equity in the business will make them feel right.
In the early days, Facebook was poor. It was a fast growing company that was throwing every spare cent it had at technology and R&D.
Just imagine where Facebook would be if Zuckerberg refused to give any staff or any investors shares in Facebook? We have all heard the wonder stories of employees or contractors who took shares in Facebook and they are now rich as a result.
Quite often for cash strapped family owned businesses the equity in the family business is the only currency they have to spend. Taking a philosophical high road on why you will not pass equity out is a guaranteed road to ruin.
If you give your staff shares they are almost always done with reversing positions to protect the family.
So if you do give shares out to staff – and the family has the ultimate power to exit all of the staff equity positions – have you really given out equity at all?
If you are going to sell the family business why not sell it to the staff?
Management buy-outs by staff from the family are not uncommon. Done carefully in a staggered process to allow the existing family owners to transition ownership to staff is a legitimate strategy for family owners who wish to provide for their retirement.
Many of our family owned businesses are not only in it for the money. The relationships and support given to the employees, suppliers and clients over the years is of critical importance.
Staff understand the value of the family legacy. They typically carry the same culture and the same values as the family and they are more likely to want to continue that position.
An outsider will often want to change the name of the business, terminate long term relationships and rip the culture of the business apart.
Many family owned businesses will find that concept unpalatable. Giving partial equity to staff will allow the legacy of the family to be retained.
The payment of dividends to employee owners in a family business is not subject to payroll tax.
Any attempt at a phantom employee share scheme, or dressed up bonus share scheme for staff attracts at whopping 5.5% additional government tax.
The dividends paid to an employee do not have to be paid to the employee themselves.
The employee has the ability to hold their shares in the family business in a trust or a superannuation fund and these dividends can be taxed at lower tax rates (or nil tax rates).
When the expenditure in the family business becomes the employees personal money: things can become more important.
Getting the employee’s financial interest directly vested into the future performance of the family business can be a great motivator for staff.
When an employee owns shares in the family business the employee will eventually sell those shares (even if it is when the employee dies).
The sale of the shares, if held for more than a year, will probably enjoy the 50% capital gains tax discount. So the tax on the ultimate sale will effectively be half of that compared to a bonus payment.
If the employee held more than 20% of the shares then other areas of law like the small business capital gains tax concessions might further increase the tax effectiveness of the shares held.
To raise capital for investors requires a lot of government regulations to protect investors.
This regulation is removed if you are issuing shares to senior staff in a family business where the staff have intimate knowledge of the business already. The saving on the advice documentation can be significant for raising large capital.
The decision to issue shares in the family business to staff is a complex and difficult one. While the benefits can be significant the downside must be carefully thought through in advance with a lot of time and thought. Let our Chartered Accountants help you devise the perfect plan for your employee share scheme.