Employee share schemes can be a powerful tool for attracting, retaining and rewarding key talent, but it is equally important to plan for what happens when employees leave.

The Enterprise Management Incentive (EMI) scheme continues to be an attractive option for business owners in Scotland looking to offer shares to key employees either on an exit basis or following a vesting period. It is a powerful way to incentivise staff, support growth and align the long-term interests of management and employees whether the goal is growth, succession planning or a future exit.

While early-stage start-ups and technology companies led the way in adopting this model, we are increasingly advising private small and medium-sized enterprises (SMEs) across a wide range of sectors throughout Scotland on employee share incentivisation.

While the benefits of employee ownership and incentivisation are well understood, what is often overlooked is planning for the departure of employee shareholders if employees gain shares in business. This is where ‘leaver’ provisions in a shareholders' agreement or the company's articles of association become critical.

At their core, leaver provisions determine how a departing employee shareholder's shares are treated, typically by distinguishing between ‘good leavers’ and ‘bad leavers’.

A good leaver, such as someone leaving due to ill health or with the board's consent, will usually receive fair market value for their shares. A bad leaver, such as someone who resigns to join a competitor or is dismissed for misconduct, will generally be required to sell their shares at a significant discount, often for a nominal value.

Why getting it right matters

Without specific provisions in either the shareholders' agreement or the articles of association dealing with departing employee shareholders, a company can find itself on a shoogly peg. The default legal position makes it difficult to force a shareholder to transfer their shares without their agreement. As a result, companies that lack robust leaver provisions may find themselves with disengaged, or even actively hostile, former employees retaining an ownership stake in the business.

In the short term, this can complicate decision-making where voting rights are attached to those shares. In the longer term, it can create difficulties during a sale process if a disgruntled shareholder refuses to cooperate or sign the necessary transaction documents.

Common pitfalls to watch out for

One of the most common issues we encounter is the use of overly simplistic good and bad leaver definitions. Life and business rarely fit neatly into predefined categories.

For example, what happens when a founder departs following an irretrievable breakdown in working relationships? Or where a dismissal is subsequently challenged? Careful drafting is required to anticipate these grey areas and minimise the potential for disputes.

Another common pitfall is failing to align leaver provisions with other key documents, such as employment contracts or EMI option terms. Inconsistencies between documents can create uncertainty and, in some cases, provide unintended advantages to departing individuals.

Valuation mechanisms also deserve careful consideration. For private companies, where there is no readily available market price, the method for valuing a departing shareholder's shares should be clearly defined and practical and cost effective to implement.

Companies should also plan for good leaver scenarios from a financial perspective. We occasionally see businesses that have not built up sufficient distributable reserves to fund the purchase of shares from a departing shareholder at fair market value. This can leave the company unable to complete the buy-back and result in frustration on all sides.

It is equally important to consider commercial fairness. While bad leaver discounts can be an effective deterrent, provisions that are perceived as excessively punitive may prove difficult to enforce and can discourage talented individuals from accepting equity incentives in the first place.

Companies considering employee share ownership are often characterised by strong levels of trust, ambition and a long-term focus on growth and succession planning. Overly restrictive conditions risk undermining those objectives and damaging the culture the business is seeking to promote.

A practical and balanced approach

Ultimately, effective leaver provisions strike a balance between protecting the business and treating individuals fairly. They should reflect the company's stage of growth, shareholder profile and long-term strategy.

What works for a start-up may not be appropriate for a family business or a more established SME, whether or not it has external investors.

Taking the time to get these arrangements right from the outset can save significant time, cost and stress further down the line.

Lindsays has extensive experience advising on employee share incentives, leaver provisions and the wider needs of SMEs, and our Corporate team would be delighted to discuss how arrangements can be tailored to meet the needs of your business.