Essential employee loan-to-purchase share scheme guide: What you need to know before signing up

If you’re new to the world of employee share schemes, a loan-to-purchase scheme can seem like a confusing and jargon-filled opportunity at first glance. But once you understand the finer details, a loan-to-purchase agreement can be an exciting opportunity towards partial ownership in a company and help your long-term wealth creation.

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What is a loan-to-purchase scheme, and how is it structured?

A loan-to-purchase employee share scheme is typically offered by companies to key talent, such as highly skilled employees. It provides an accessible way for you as the employee to purchase shares upfront in the company at market value via a loan. This loan is usually provided by the company or a financial institution it has partnered with. In the former case, it’s not uncommon to be offered at a low or zero interest rate. 

If you sign up for a loan-to-purchase scheme, you will typically repay the loan via your salary and/or any company dividends you earn. Depending on the structure of your loan, you may also be able to contribute cash bonuses you earn from the company towards your loan repayment. 

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What are the benefits and risks of a loan-to-purchase scheme?

One key benefit of opting into a loan-to-purchase scheme is the ability to become a partial owner of the company without a large upfront financial investment. Employee share schemes such as loan-to-purchase schemes allow you the opportunity to build long-term wealth without the upfront financial outlay that comes with other traditional investments, such as property or the share market. 

A loan-to-purchase scheme can also provide you with potential future capital gains and associated dividend distributions. A third benefit of participating in a loan-to-purchase scheme is the owner mentality and enhanced sense of purpose and alignment with the company’s goals and direction it provides employees.

However, there can be risks associated with a loan-to-purchase scheme that it is important to be aware of. Before signing any agreement, we recommend that you consult with an independent financial advisor who can take you through the legal agreement in more detail. It’s important to be aware of the financial impact that failure to repay the loan could have on you and be aware that the value of your shares may decrease instead of increase. Therefore, it's important to ensure you create alternative financial safety nets to combat any potential financial loss. 

Other risks to be aware of are potential tax implications if the shares are offered at a lower price (i.e. discount) than the fair market value. Income tax may apply for the difference between the price the shares are purchased for versus the fair market value at the time of purchase.

Finally, it's important to consider the impact that leaving the company before the loan is repaid will have on your shares. If you leave the company before the loan is repaid, the company may have the ability to claw back those shares and also may have the right to purchase back any shares (usually at fair market value) you have paid down whilst you were working for the company.

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What are your responsibilities and rights in a loan-to-purchase agreement? 

It's important to be aware of your responsibilities and rights before entering into a loan-to-purchase scheme agreement. As well as your responsibility to repay the loan according to the loan agreement, these also include being aware of: 

• Whether the loan is a full recourse loan or not: A recourse loan holds the borrower (the employee participant) personally liable for the loan, which is taken out to purchase a stake in the company. Depending on whether the loan is a full recourse or not will also influence whether the company has a right to pursue loan repayment even if the value of shares decreases (i.e. the employee has a loan that is more than what the shares are worth). 
• Voting rights: Depending on the nature of the loan-to-purchase agreement you enter into, you may have the right to vote at shareholder meetings. However, in most cases, loan-to-purchase scheme agreements do not include voting rights. 
• Are dividends applied to the loan? Check to see whether any dividends received from the company will be automatically applied to the loan, whether they will be paid in cash, or whether they will be split between the two. 
• Will shares be held in a trust? It’s important to note that when shares are held within a trust on behalf of you, the employee, the employee is not technically a shareholder; instead, they hold a beneficial interest in a certain number of shares. This means that personal information such as name, address, and the number of shares that an employee has a beneficial interest in remains private. In addition, it may mean that the trustee has control of voting and rights relating to the shares.

Access to your loan-to-purchase agreement: If your employer is with Orchestra, you can track your loan-to-purchase employee share agreement in real time via Orchestra’s easy-to-use online dashboard. Here you’ll find all the loan-to-purchase documents and details from your agreement, alongside any other privately held shareholders you may have.

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What are the key terms you need to know?

At first glance, a loan-to-purchase agreement can seem confusing and packed with unfamiliar jargon. Below, we’ve outlined some of the key terms you will encounter: 

• Accrual - the accumulation or increase of interest over time. 
• Dividend distributions - the distribution of a company's earnings to eligible shareholders. 
• Employee ownership - an arrangement in which an employee can own shares in the company they work for or the right to the value of shares in the company. 
• Fair Market Value - an asset's estimated value if it were sold today in the current market.
• Loan - the loan of money to an employee by the company or an associated financial institution. 
• Loan-to-purchase agreement - is the agreement between an employee and a company for the employee money to purchase shares upfront, via a loan, in the company at market value. 
• Interest - the price paid to borrow money or the return earned on an investment. 
• Offer - the contract made to an employee through an employee share scheme offer letter.
• Recurring payments - a company automatically deducts an employee's loan repayment on a regularly scheduled basis.
• Repayments - the act of paying back the loan to the company. 
• Shareholding - the shares in a company that a shareholder owns

If you would like to track your loan-to-purchase scheme alongside other privately held shareholdings, contact the Orchestra team to learn how our platform can help.

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