What the Employment Rights Act 2025 means for small businesses

Context

The Employment Rights Act 2025 received Royal Assent on 18 December 2025, representing what the government describes as "the biggest upgrade to workers' rights in a generation". Implementation is phased across 2026 and 2027, with the first major wave of changes—Statutory Sick Pay from the first day of sickness, and day-one paternity leave and unpaid parental leave—taking effect on 6 April 2026. The Fair Work Agency was established on 7 April 2026. Employment tribunal time limits increase from 3 to 6 months on 1 October 2026. The government plans to bring in third-party harassment liability on 30 October 2026 and fire-and-rehire protections in January 2027, subject to parliamentary processes. For dismissals with an effective date of termination on or after 1 January 2027, the unfair dismissal qualifying period reduces from 2 years to 6 months. Extended bereavement leave, including for pregnancy loss, is planned for 2027.

Most of the Act does not apply in Northern Ireland, where employment law is devolved, although its Statutory Sick Pay changes do. For businesses operating across Great Britain, this creates a period of significant regulatory adjustment at a time when many SMEs are already managing the cumulative impact of National Insurance increases, National Minimum Wage rises, and a challenging economic environment.

The government's economic analysis estimates the Act will increase employment by around 0.1% and GDP by around 0.04%, with 18 million employees benefiting in some way. However, this aggregate view masks significant variation in how the costs and benefits are distributed. For small and medium-sized businesses—particularly those in labour-intensive sectors such as hospitality, retail, and social care—the compliance burden and loss of flexibility represent a material shift in employment risk.

The SME compliance cost burden

The government's impact assessment acknowledges that the most direct and immediate effect of the Act is a 'transfer' from employers to workers—a cost to employers and benefit to workers. For large employers with dedicated HR and legal teams, these costs are absorbed within existing infrastructure. For SMEs, the picture is markedly different.

The Federation of Small Businesses (FSB) has highlighted that many small firms lack in-house HR expertise. As FSB Policy Chair Tina McKenzie points out: "We can't have a situation where small firms are scrambling to implement numerous changes at once, as it will cause chaos and have a huge impact on hiring."

Sarah Ropek, founding HR partner at The Fractional HR Department, observes that "the biggest impact for small businesses will come from higher baseline employment costs and reduced flexibility when change is needed." Unlike large employers who can spread costs across hundreds or thousands of employees, SMEs face disproportionate per-employee compliance costs. Updating contracts, policies, handbooks, payroll systems, and training managers—all necessary to comply with the new rules—represent a fixed overhead that weighs more heavily on businesses with 10, 20, or 50 employees than on those with 500 or 5,000.

Day-one rights: the end of flexible probation

The shift to day-one rights for Statutory Sick Pay, paternity leave, and parental leave removes a key flexibility that SMEs relied upon during the critical early months of employment. Previously, employers could assess new hires during a probationary period with lower statutory payment exposure. From 6 April 2026, all employees—including those on their first day—are entitled to SSP from day one of sickness, with no waiting days and no lower earnings limit.

For large employers with sophisticated absence management systems and occupational sick pay schemes, this is an incremental change. For small businesses, particularly those in sectors with variable attendance patterns (hospitality, retail, construction), the immediate cost exposure is significant. The FSB has called for a rebate scheme for small businesses, noting that without it, "more small firms will be deterred from hiring without financial pressures."

The government's analysis argues that removing barriers to statutory payments will reduce staff turnover and improve recruitment by making employment more attractive. Legal commentators from Blake Morgan note that "employers should prepare for higher SSP costs, as there will be no rebate scheme for small businesses." This asymmetry—immediate costs to employers with speculative long-term benefits— is characteristic of several ERA 2025 provisions from an SME perspective.

Fire and rehire: loss of a restructuring tool

The fire-and-rehire restrictions in the Act have been described by Lewis Silkin as "a major block to changing outdated or unprofitable pay, pensions and hours structures." For SMEs facing seasonal variation, competitive pressures, or operational changes, the ability to vary employment terms was a last-resort mechanism when voluntary agreement could not be reached. Once in force (the government's planned date is January 2027), the Act makes dismissal to impose 'restricted variations'—including reductions in pay or time off, changes to pensions or working hours, and shift changes meeting conditions set in regulations—automatically unfair, with only a very narrow exception.

That exception is extremely limited. The employer must show the reason for the change was to eliminate, prevent, significantly reduce or mitigate financial difficulties affecting, or likely in the immediate future to affect, its ability to carry on the business as a going concern, and that it could not reasonably have avoided the change. It does not cover routine cost-cutting or efficiency measures. As Lewis Silkin notes, "Many employers who previously used fire and rehire will not qualify for this exception."

For large employers with diverse workforces and multiple business units, this may require more strategic workforce planning and consultation. For SMEs—particularly seasonal businesses in hospitality, tourism, and retail—the removal of this tool creates genuine operational challenges. An advertising agency seeking to streamline front-of-house functions, or a hospitality business adjusting to post- pandemic trading patterns, will no longer be able to restructure using dismissal and re-engagement. The Act forces negotiated agreement or acceptance of a two-tier workforce with different terms—both of which create practical and relational difficulties in small teams.

The government argues that ending "unscrupulous fire and rehire practices will prevent pay and terms being cut for thousands of workers each year." The question for SMEs is whether the ban—in removing a legitimate tool alongside its abuses—leaves smaller employers without viable mechanisms for necessary change.

Fair Work Agency: enforcement risk and SME vulnerability

The Fair Work Agency (FWA), established on 7 April 2026, consolidates enforcement functions across multiple existing agencies into a single body with "wide-ranging powers aimed at strengthening enforcement of certain workplace rights." As Make UK describes it, the FWA will "investigate and take action against businesses that do not comply with the law."

The government's position, articulated in Parliament, is that "when changes are made, SMEs will have clearer instructions, simpler routes to advice and a single enforcement body—the Fair Work Agency— rather than several other bodies that currently exist." This consolidation may indeed simplify the landscape in the long run. In the short term, however, SMEs face a new enforcement regime at precisely the moment when multiple substantive rule changes are being implemented.

Large employers with compliance infrastructure, legal counsel, and HR audit functions are well- positioned to demonstrate regulatory compliance. SMEs—particularly micro-businesses—are less likely to have audit-ready records, documented policies, or systematic evidence of compliance. When an employer with 15 employees is investigated by the FWA for an alleged national minimum wage underpayment or a breach of employment agency rules, the absence of sophisticated HR systems becomes a material disadvantage. As employment law specialists at Farrer & Co observe, the FWA will be "an advisory and enforcement agency," but for businesses without existing compliance systems, the enforcement risk may prove more salient than the advisory support.

Third-party harassment: customer-facing SMEs at greatest risk

One of the most significant provisions for customer-facing SMEs is the third-party harassment liability that the government plans to bring in on 30 October 2026, subject to parliamentary processes. Under the Act, employers will become liable for harassment of their employees by third parties—such as customers, clients, delivery drivers, or members of the public—unless they have taken "all reasonable steps" to prevent it.

Legal analysis from TLT specifically identifies retail and hospitality as high-exposure sectors: "Employees regularly interact with customers, delivery drivers, contractors and other third parties, creating high exposure to potential harassment risks." The Act also strengthens the existing duty to prevent sexual harassment, in force since 26 October 2024, from taking "reasonable steps" to "all reasonable steps"—a materially higher standard.

For a large retail chain with dedicated compliance teams, implementing preventative policies, customer codes of conduct, staff training, and incident reporting systems is operationally feasible. For a small pub, café, or independent retailer with a handful of staff, the practical question is: what constitutes "all reasonable steps" when a customer harasses an employee? As employment law specialists at Lexology note, this is "particularly significant for hospitality" where "employers can now be held liable for harassment of their staff by third parties, such as customers or delivery drivers, if they haven't taken the necessary preventative measures."

The asymmetry is clear: SMEs in customer-facing sectors have the highest exposure (frequent third-party interactions, less control over customer behaviour) combined with the lowest resources to implement comprehensive preventative systems. Tribunal awards for harassment are uncapped, and tribunals will assess whether "all reasonable steps" were taken based on what was practicable for that employer. Whether tribunals will calibrate their expectations to the size and resources of the business remains to be seen.

What stakeholders are saying

Employer bodies: The British Chambers of Commerce (BCC) has expressed that business is "wary" about the new employment rights. Kate Shoesmith, BCC Director of Policy, noted that to secure the six-month qualifying period for unfair dismissal and progress further negotiations in secondary legislation, "we believe it should now be passed"—a pragmatic acceptance rather than endorsement. The BCC's earlier research found that businesses were "worried about the speed with which the Employment Rights Bill is being put through Parliament and have serious concerns about it."

The FSB has consistently emphasised implementation timing and support. Tina McKenzie's statement that "a staggered rollout, with the detailed rules being negotiated with FSB and other business groups, would show they understand the reality small firms are facing" reflects a desire for phased implementation that allows SMEs to absorb changes without overwhelming their limited administrative capacity.

Legal commentators: Employment law firms have focused on the need for immediate preparation. Blake Morgan advises that "employers should monitor developments" and "prepare for higher SSP costs." Farrer & Co emphasises that the Act will require "far-reaching" changes and that "understanding the implications will be essential for HR and business leaders preparing for implementation." Squire Patton Boggs recommends that employers "not wait reactively as they come into effect" but instead treat the Act as "fundamental changes to the employment law landscape in the UK [that] will impact all employers."

Worker representatives: The TUC and individual unions have welcomed the Act as overdue protection for workers in insecure employment. The government's analysis highlights that "it will be those who are lowest paid in the labour market, in sectors such as social care, hospitality and retail, that will benefit most"—the same sectors where SMEs are concentrated. From this perspective, the Act corrects an imbalance where smaller employers in labour-intensive sectors have relied on flexibility that left workers vulnerable.

The counterargument: levelling the playing field

The government's economic analysis argues that strengthening employment protections will "boost employment, improve job quality and productivity, and create fairer competition." Professor Simon Deakin of the University of Cambridge, whose research informed the government's approach, states: "The research we have done in Cambridge shows that on average, strengthening employment laws in this country in the last 50 years has had pro-employment effects. The consensus on the economic impacts of labour laws is that, far from being harmful to growth, they contribute positively to productivity."

From this perspective, the Act's provisions do not impose costs on SMEs—they level a playing field that was previously tilted in favour of employers who competed on low employment standards. The government's analysis notes that the Act will deliver "a small, positive direct impact on economic growth," with modelling showing it "could increase employment by around 0.1%, and GDP by around 0.04%." If lower-paid workers gain security, purchasing power, and attachment to employment, the aggregate benefits may offset the compliance costs.

There is also an argument that professionalising employment practices—even in small businesses— reduces costly turnover and grievances. Businesses that already operated fair probation processes, paid sick pay from day one, consulted genuinely on changes, and prevented harassment will see minimal impact from the Act. It is those that relied on flexibility to avoid costs who face the greatest adjustment.

What to watch

Several critical details remain to be determined through secondary legislation and guidance:

• Zero-hours contracts: The reference periods and notice requirements for guaranteed hours offers and shift notice are set in regulations still subject to consultation. These measures are expected in 2027, and the government has said their timings will be updated after consultation. The government has committed that "all relevant factors, including impacts on seasonal workers, will be taken into account when making secondary legislation."
• Fire and rehire exceptions: A government consultation on how changes to expenses, benefits, and shift patterns should be treated closed on 1 April 2026. Regulations following it will determine which contractual variations fall within the "restricted variation" definition and may provide clarity on the scope of permissible change.
• Fair Work Agency enforcement strategy: The Act requires the government to produce an annual report on the FWA's work and an enforcement strategy every three years. How the FWA prioritises sectors, firm sizes, and complaint types will shape the practical enforcement risk for SMEs. If the FWA focuses on systematic non-compliance and egregious cases, technical breaches by well-intentioned small employers may be deprioritised. If it takes a legalistic approach to enforcement, SMEs will be exposed.
• Steps to prevent sexual harassment: The Act includes a power, planned to come into force on 30 October 2026, for ministers to make regulations at a later date specifying steps employers must take to prevent sexual harassment, alongside the broader duty to take "all reasonable steps". Whether any such steps are proportionate and practicable for small employers will be critical. If they set expectations calibrated to large employers, SMEs will struggle.
• Tribunal approach to uncapped awards: With the compensatory award cap removed for unfair dismissals with an effective date of termination on or after 1 January 2027, tribunal awards for high earners will potentially reach significant sums. How tribunals assess "actual losses" for SME employees—and whether they apply Polkey reductions and contributory fault findings generously or strictly—will determine the financial risk landscape.

The government has committed to "continue to undertake comprehensive engagement and consultation on the implementation of Make Work Pay and the Employment Rights Act 2025, to ensure that these changes work for both workers, and businesses of all sizes." For SMEs, the extent to which secondary legislation, guidance, and enforcement strategies accommodate their limited resources will determine whether the Act represents a manageable evolution or a step-change in employment risk.