Employee share award implementation

Blending share awards with options for maximum advantage

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Employee share award implementation

We advised a UK company on how to provide its senior employees equity incentives. Our client wanted to incentivise the team to build the business and increase profitability. The problem was the employer wanted to avoid substantial tax liabilities for its employees. At the same time the employer wanted to offer its senior team the incentive of dividends. 

The solution

The solution we proposed was a combination of EMI options coupled with shares which gave a right to dividend but not to capital or voting rights.

The process we applied to find the solution

We took our client through the available choices which included:

  • EMI options;
  • Ordinary shares carrying rights to dividends, voting and capital;
  • A special class of shares which carried restricted rights such as only the right to a dividend; or
  • A mixture of the above.

We narrowed down the choices to those which would achieve the objectives.

We did mention that there were many other types of employee share plans available but none as suitable as those selected for discussion.  CSOP options are not as flexible as EMI.  SAYE and SIP plans have to be made available to all employees which was not the intention of the employer.  Unapproved options are often not suitable if the business can qualify for a tax approved share plan such as EMI options.

EMI options

The intention was to encourage the senior employees to build the business and prepare for a trade sale.  EMI options were the best choice for the employer as they can be implemented on the basis that the employee only receives a benefit on the actual sale of the company.  The benefit conferred is the right to receive a share of the sale proceeds equal to the number of shares awarded under option.

  • EMI was attractive as the employer has a discretion over the size of each award and hence tight control on shareholder dilution.
  • There was no tax charge for the employees on award of the EMI option.

The problem

However, our client felt uncomfortable giving away equity to employees who could leave before the sale.  Also, EMI options do not carry the right to receive dividends.

The solution

The solution was solved by:

  • Drafting into the EMI documentation a requirement that if the employee left the business the EMI option would automatically lapse;
  • Retaining some flexibility for special cases via an over riding power of discretion given to the employer; and
  • Implementing dividend only bearing shares – see below.

Dividends

Our client wanted the senior team to receive dividends.  The business was profitable and did have distributable profits enabling dividends to be paid.

The problem

The problem for the employer was that it wanted to regulate the size of dividend the senior team employees received.  The employer wanted to retain the flexibility to pay other shareholders larger dividends.  The founders received much smaller salaries than the senior team employees topped up by dividends.  There had to be the power to regulate that.

The solution

We  created a special class of shares for the employees which only conferred the right to receive a dividend.  We amended the articles of association to ensure that if the employee left the company could reclaim the shares.

  • Rights to capital, such as the right to benefit on a sale of the business, were not given because the EMI options provided the right to capital on sale.
  • We dealt with the share valuation and tax issues arising on the award of the special class of shares.  The tax payable by employees was controlled because a share that only provides a right to a dividend is of lesser value than a share which provides full shareholder rights.
  • The articles included the power to “drag” the senior team into a sale approved by the founders.  This removed the risk of a sale being hampered.

Helen Curtis regularly advises businesses based in the UK and overseas on the implementation of employee share plans.  Helen has the skills to recommend the best ideas for companies at all stages of development from start up through to those nearing exit and businesses at the stages in between such as fund raising.