Worklife 2.0: Employers of record – the sky is the limit? Part 1 – Equity-based incentives

Part 1 – Equity-based incentives

We are seeing an increasing number of companies partnering with “employers of record” (EoRs). This arrangement is particularly popular amongst companies in rapid growth mode (including many in the tech sector), EoRs “employ” individuals in countries where the companies themselves do not have a formal corporate presence. This allows them to access global talent and expand into new jurisdictions with relative ease and speed. US companies, who are already familiar with the use of third-party employment agencies across state borders, are also keen subscribers to EoR services.

This is the first in a series of blog posts exploring how to partner with EoRs and navigate the relevant legal landscape successfully. 

Background

So, what do we mean by an EoR? Essentially, an EoR is a third-party entity that acts as the legal employer of individual employees but provides the services of those individuals exclusively to an end user.  EoRs are attractive partly because they handle the administrative aspects of the employment relationship, such as payroll, statutory benefits, immigration and tax reporting. EoRs, therefore, differ from third-party HR consultants or payroll providers in that they serve as the formal employers, and their service offerings are much more comprehensive. 

Behind that tripartite legal relationship, from the perspective of EoR employees, they (continue to) work as if they are employees of the end user. The end user has direct working relationships with the EoR employees on a daily basis – for example, work allocation and supervision.

EoR arrangements expedite access to talent in new jurisdictions, and can even allow existing talent to relocate to more exotic locations, something we have seen much more of in the aftermath of the pandemic. With some EoRs offering services in multiple jurisdictions, the end user can avail itself of the services of global EoR employees without the hassle of setting up multiple overseas entities.

However, there are some points that should be addressed early when partnering with an EoR to ensure that the arrangements work optimally and do not inadvertently cause compliance issues. This blog post focuses on the feasibility of equity-based incentives for EoR employees.

Equity-based incentives

Equity awards can be an effective way of rewarding and incentivising talent and fostering corporate identity.  So companies are often keen to offer equity to all those individuals who work for them (whether as employees or through an EoR). But, in the case of EoR employees (who are not legally employees of the end users), granting equity awards can be more complicated.

In certain jurisdictions (for example, in the US), there is an established practice of granting equity awards to non-employees such as independent contractors and non-executive directors. In these jurisdictions, granting equity awards to EoR employees can proceed in the ordinary course, subject to continuing compliance with relevant securities filings requirements.

In other jurisdictions, such as the UK and some European states, a lot of the legislative framework around equity awards assumes that they will only be granted to legal employees of the issuer – which means that many of the exemptions that companies rely on as a practical matter when operating their equity incentive arrangements will not be available if they extend them to EoR employees.

Company laws

For example, if the end user is a UK-incorporated entity, allowing employees of an EoR to participate will take the equity plan outside various corporate law exemptions with the consequence that additional shareholder approvals are likely to be required and that, for listed companies, operation of the plan could constitute unlawful financial assistance (previously discussed here).

Securities requirements

Grants of equity awards are normally exempt from the European prospectus requirements if they are made to employees. The same exemption, however, is not available in respect of EoR employees, and issuers would need to identify other exemptions (or comply with the prospectus requirements), for example, based on the number of individuals and monetary quantum involved.     

Financial promotion

Many European jurisdictions, including the UK, have restrictions on financial promotions that bite on communications around equity awards and can carry criminal liability if breached.  In practice, equity awards to employees normally fall outside of these restrictions due to exemptions available for employee share schemes. But that exemption is unlikely to be available in respect of EoR employees who are technically not employees of the end user (or its group). In that case, end users need to seek to rely on other exemptions. Alternative exemptions may be available, for example, based on the net worth of EoR employees due to receive the grants. This entails a fact-specific analysis to be undertaken with legal advisors and could mean a different outcome in terms of the ability to grant equity for EoR employees ultimately performing the same job. It can also make offering equity as part of a job offer more difficult – because the offer of equity may not be able to be made until the individual’s personal financial circumstances are known. This is a point that will need to be thought about when partnering with an EoR.

Tax reporting

If equity awards are being considered, and it is possible for the parties to overcome the hurdles described above, end users and EoRs should also determine who will be responsible for the various tax reporting obligations in relation to the awards. In the UK, for instance, arrangements relating to employee-related securities (which would capture awards to EoR employees) must be registered, and annual filings must be made in relation to activities such as grants and exercises. As mentioned, one of the primary benefits of partnering with an EoR is their handling of payroll taxes, and end users may, therefore expect EoRs to assume the tax filing obligations in relation to equity awards. However, due to EoRs being a relatively new phenomenon, the allocation of responsibilities between end user and EoR hasn’t necessarily been considered in all cases, particularly when it comes to jurisdiction-specific requirements. This will need to be discussed between the parties.

Other considerations

As mentioned above, equity-based incentives are one of the many legal points that will need to be considered in a partnership between end users and EoRs. Other topics include: handling of personal data between end users and EoRs; compliance with pension enrolment requirements; corporate tax residence implications; management of employee culture and internal investigations; proper assignment of intellectual property rights; the implication of transactions on end user employees and EoR employees; and compliance with restrictions on employee leasing.

Watch this space for future blog posts tackling each of these matters, or for more information on EoRs and their utility for rapidly growing companies, please speak to the authors of this post or your usual Freshfields contact.