Guide to the system

9. Guide to the system

The documents below are not provided for you to use as they are. They are provided for you to take to your professional advisors (lawyers, accountants, management consultants) for them to advise you on, as to whether they are fit for your use. I am neither a company lawyer nor an accountant, and I make no warranty as to these documents’ fitness for purpose. I will not be liable if they turn out to be unfit. You use them at your own risk, after taking appropriate professional advice.

But, on that basis, anyone is free to make use of these documents free of charge. My only other condition is that you acknowledge that I created them.

The Company Rules (Appendix 1)

Articles of Association are the rules of the company. How it is run, governed and owned. They say how the people inside the company treat each other, like a constitution.

See the template Articles of Association, at Appendix 1 of this book. I call these the Company Rules.

The preamble: “WHEREAS… “.

This is rare in Rules, but is for guidance of any judge as to the intention of the parties signing up.

  • The main purpose is to align workers’ and investors’ incentives, so that they are on the same side. This is the point of making everyone an owner.
  • The value of shareholdings is to be “safeguarded”, i.e. the rules are to be interpreted to prevent anyone unfairly reducing the value of your shares.
  • The aim is to make employee share ownership workable, for all the reasons above.
  • Free trade in the shares is to be encouraged, because the easier it is to sell them, the keener people will be to buy them and the higher the value of the shares will be.

Shares

There is one class of shares, “Ordinary Shares”. Dividends are paid equally between all shares.

Each share gets 1 vote at company meetings.

Member Authorisation

But on some votes, shares are divided into two groups: (a) Employee Shares and (b) Investor Shares. These groups vote separately, and both groups have to agree. This is called “Member Authorisation”.

Member Authorisation is to prevent capital and labour (investors and employees) from shafting each other. Decisions where they might be tempted to do so require Member Authorisation.

The aim is to use this as little as possible because it creates admin. The point is to safeguard each group’s interests by putting in checks and balances. That is central to these Rules.

The Fair Price

The Fair Price is the price at which the Directors can allot company shares to new employees without Member Authorisation. They can sell shares to others (apart from Close Associates) without Member Authorisation. The idea is to make it quick and easy for the company to get investment bys selling shares in the company to investors.

Close Associates

This basically means friends, relatives and business colleagues of employees or Directors. The aim is to prevent shares and money being paid out corruptly.

The Employee Trust

This body holds shares for employees. It is easier to administer the shares together. It is easier to take votes of employee shareholders. It means that employees are not liable to pay the value of the shares if the company goes bust. Employee shareholders elect the Trustees, on one-share-one-vote.

The Investor Trust

This does the same as The Employee Trust, for Investor Shares. The only difference is that Investor Shares will usually be fully paid up.

Transfer of Shares

If your shares are fully paid for, with no money owing on them, you can sell them to anyone. The idea is that if a market grows up in these shares then investors will be more attracted – they’ll be prepared to buy shares in the company, because they’ll know they can sell them on again. Employees can’t generally sell Employee Shares because those share usually aren’t fully paid up.

The valuation formula

This is far from perfect because a share is only worth what someone will pay for it, not what any formula says. But it has to be set up so as to work out shareholdings when an Employee joins and leaves.

Auditors

They do the accounts every year, and authorise company spending. They say what directors can and can’t spend out of company money, i.e. whether the thing being paid for is a business expense. This stops Directors or Employees using the company as a slush fund to buy things for themselves. The Auditors are chosen by Investor Shareholders. This is one of the checks that balances out the day-to-day control that Employees will have if they own more shares than Investors, as they most likely will.

Directors

They run the company, and are appointed at a vote at a General Meeting. A General Meeting is where all company shareholders can vote, on one-share-one-vote. Employees will usually have the biggest vote here. So they will be able to vote in the Directors they want.

It is possible that this gives Employees too much control over the day-to-day running of the company. In which case Directors can be chosen by Member Authorisation.

Employment Contracts

These are signed by each Employee when he starts work for the company. The difference between this and other employee contracts is that here, the company Rules are written into this one.

Employee Share Ownership

This comes about by issuing Employee Shares that are “not paid up”, i.e. with the purchase price owing on them. But the Rules also allow the company to lend money to the Trust to buy Employee Shares, fully paid up, on behalf of an employee. This isn’t used here, because it might be subject to aggressive taxation.

Retained Profit

This is what gets ploughed back into the business each year. The total profit has to get paid out each year in dividends, because that is Employees’ pay. And if it’s paid out to Employees, then it is paid out to Investors too. Investors may voluntarily hand back their dividends, but why would they? So the Rules set our a percentage of the profits that get ploughed back into the company each year. This isn’t ideal, since a company might want to change how much it ploughs back each year. But the percentage of retained profit can be changed by Member Authorisation.

Loans to Employees

This is a useful option to retain in case dividends are only paid out at the end of the year. Employees have to survive! It is better to pay dividends each month because loans make employees nervous.

The Employment Contract (Appendix 2)

An employee gets (a) a basic wage, plus (b) shares in the company, which yield dividends each month. The dividends go up and down as the profits in the company go up and down.

The employee’s shares are transferred into the Employee Share Trust, which holds them for the employee.

When the employee leaves, the shares are re-valued, and if they have gone up in value, the employee keeps the excess value in the form of shares, credited as fully paid up. So if the shares have doubled in value, the employee leaves with half his shares. And he gets dividends on those shares year after year. Like a second pension.

If the shares have gone down in value, the company buys them back at the initial price. So the employee leaves with no shares but owing no money.

An ex-employee can sell his shares, but the Contract gives the company the right of first refusal.

The Trust Deed (Appendix 3)

This is the document that sets up the Trust that holds shares on behalf of employees.

The shares in the company are transferred to the Trust on behalf of each employee as each employee joins.

Those purchase price is permanently owed by the Trust to the company, i.e. the shares are not “paid-up”.

If the company goes broke, then it is the Trust, and not the employee who owes the company (or its creditors) the purchase price of the shares.

Employee Shareholders can elect and replace the Trustees on one-share-one-vote.

Share Transfer Agreement (Appendix 4)

This is the document by which the company transfers shares into the Employee Share Trust, when the employee joins the company.

The company doesn’t receive money for these shares at this point. These shares are, and remain un-paid up during the employee’s period of employment.

The Trustee Company documents (Appendix 5)

These are the incorporation documents for registering the Employee Shareholder Trustee company. These documents are nothing to do with the main company rules, and not significant in themselves. They’re included here for completeness.