The recruitment sector is a good barometer of change in the jobs market and can hit headwinds when employers put on the brakes when it comes to hiring. It remains to be seen just how hard the sector gets hit this year with businesses expressing some concern about the impact of the increase in employer National Insurance (NI) from 6 April 2025 and the new Employment Rights Bill changes.
For those recruiters operating in executive search practices and industry niches however, where skilled talent remains in high demand but short supply, there is an opportunity to keep building value and growth.
Recruitment businesses can be harder to scale and sell; the assets are very much the people in the business, their expertise and connections. Many remain founder-led and, even with robust post-termination restrictions, there is latent risk that star recruitment consultants break away and set up rival agencies once they have gained sufficient experience under their belts.
It is a sector where, like estate agents, there is a historic expectation of sales-driven bonuses and commission. Ultimately such rewards are short-term motivators that do not always drive the best behaviours when it comes to growing a team, working collaboratively, leveraging connections, and working for the benefit of the whole business to build aggregated value, sustainably, for the longer-term.
For many reasons, not least the incoming hike in employer NI and a general air of caution regarding curbing cash spend, it may be time to wean some in the recruitment sector off a heavily weighted reliance on annual variable pay delivered in cash. Now could be a good time to refresh the balance between drip-feeding of short-term rewards (although some annual cash reward will still be needed) and longer-term reward in equity form.
Alignment of interests and financial benefits using employee share plans
Employee ownership aligns the interests of the employees with those of the business. This alignment can lead to better decision-making, as employees understand that their actions will have a direct impact on the company's success and their personal benefit over the longer term. This shared interest can foster a more collaborative and innovative work environment, driving the business forward.
Employee-owned companies can also enjoy financial advantages. Studies have shown that such businesses are more resilient during economic downturns and have a higher rate of growth compared to their non-employee-owned counterparts.
The incoming legislative changes
Key changes arising from the October 2024 budget are the increase in employer NI and the increase in Capital Gains Tax (CGT). The increase in employer's NI cost (which is driven by both a lowering of the threshold and increase in rate) is steering employers to critically assess headcount and talent requirements for the coming year and to review the total reward package offered. When considering any headcount reduction, consideration needs to be given to leaver treatment and whether those made redundant will be allowed to benefit from any equity incentives previously granted to them. For those retained, choosing to use equity incentives, rather than cash, to boost potential total reward over the medium term can deliver savings for both employer and employee. Some larger, usually quoted companies in the recruitment sector operate statutory all-employee share plans (i.e. Save As You Earn (SAYE) or Share Incentive Plan (SIP)), with SIP being the only plan that allows awards of shares to be made to employees with no cost of acquisition and no tax charge, even on ultimate disposal of the shares. Private, entrepreneurial agencies look to Enterprise Management Incentives (EMI), Company Share Ownership Plan (CSOP) and growth share arrangements, but larger, privately owned agencies can, and do, use SIP too. The benefit of share plans is multi-faceted, enabling:
- retention and focus on sustainable value creation and growth driven by attainment of medium-to longer-term strategic business aims, as the ultimate pay-out is dependent on achieving these strategic goals;
- reduced cash spend as the reward is equity settled initially;
- where the business and participants are eligible, tax-advantaged arrangements can produce material tax and NI savings for the business and employees;
- a commitment filter to identify those who see themselves as value-additive and loyal to the business brand in the longer term, and potentially an uncapped future incentive that will deliver more post-tax spending power reward for your top talent.
Succession planning and unlocking the value of your business
For the reasons set out in our earlier article, founders and owners have been exploring various succession choices and wondering when the time is to act and what the best path is to take. The increase in standard CGT rate (to 24%) and tapering away of Business Asset Disposal Relief has made the savings delta greater when comparing a share disposal to an Employee Ownership Trust (EOT) (due to an uncapped relief from CGT if the qualifying conditions are met) and any other form of exit route.
Tax is, of course, just one consideration when crafting a change of control transaction and should not be the driving motivator. Nevertheless, if the headline valuation of a business is not as high as owners hoped, due to challenging trading conditions and stalled growth, it can be tempting to preserve value by mitigating tax leakage in a transaction. Often the litmus test for proceeding with an internal form of succession, for example via an EOT, is driven by the valuation assessment and whether that meets shareholder needs and expectations, whilst being affordable for the business to self-fund the buy-out. HMRC has become attuned to the fact that some valuations may have been prepared on a very optimistic basis and, consequently, the 2025 Finance Bill, which will receive Royal Assent in the coming weeks, introduces new provisions, applicable to all EOT arrangements established from 30 October 2024, to curb the perceived abuse. Among these changes, is the introduction of a statutory obligation on EOT trustees to take all reasonable steps to ensure that the valuation of vendors' shares is not inflated. The new legislation also introduces new measures in relation to requiring the EOT to be onshore, and new provisions regarding the composition of the trust board extend the period of time for which vendor tax relief is kept at risk in relation to occurrence of any disqualifying event, and also requires additional disclosure reporting by vendors.
The driver for legislative change has been concern that the generous EOT relief was being abused by some. With the recent hike in standard rates of CGT the tax saving difference is now wider than ever before. HMRC frequently opens enquiries into such and we anticipate that EOT trustees, vendors and company boards may increasingly seek an independent, second adviser, for advice both pre- and post-transaction to ensure a watertight and robust implementation of arrangements before, during and after such an ownership succession handover.
While a full-blown buyer due diligence exercise will not be required for an internal ownership succession transaction, there should still be a health-check on legal and tax risk with suitable disclosure to the buyer, something to which independent trustees are becoming more attuned, as failures can put at risk the company's ability to fund a buy-out. If the expectation is that the sale event delivers a capital transaction with associated reliefs, it can be most unwelcome to hear that an earnings charge to PAYE and NIC can be triggered under the employment-related securities provisions due to historic tax compliance errors.
Often the CGT exemption is the headline focus and the Inheritance Tax consequences of selling shares in exchange for an initial cash sum and then a deferred consideration amount can be overlooked. With multi-disciplinary advice support, the outcomes can be further optimised with suitable pre-transaction planning. Taking some money off the table and de-risking an owner's personal wealth position can be a key reason why a shareholder seeks to partially (or fully) divest a shareholding to an EOT. The CGT saving is significant but there is a trade-off. The HM Treasury policy rationale for the generous tax relief is that the vendor assumes the risk of not getting paid in full. It is, in essence, a patient capital form of exit that is self-funded from future business profits. Seeking to circumvent that risk, by leveraging the business with debt finance to accelerate payment can financially stress the business to breaking point. Seeking to place a charge or debenture over any trading property assets of the business can undermine the tax relief and create other iterations of tax charge for the vendor.
The devil is, as always, in the detail and the detail just got more detailed, with some new small print legislation added. This article just touches on some of the changes and there are others that will need consideration too, depending on individual scenario facts and circumstances.
If you wish to explore employee share plans for your workforce or consider an EOT as a succession solution, then our experienced experts can assist. If you are concerned that your existing arrangements might merit some review and attention or you need support with an HMRC enquiry, we can help.
For further information contact Liz Hunter.