It is easy to make mistakes when providing share incentives to staff. This is because the issues are potentially complex especially in private companies before exit stage. We simplify the process. Our specialist expertise spans design, tax, legal, drafting and share valuation which means we deal with all the aspects cutting down on the number of advisors and hence your cost. Our experience enables us to take you to the best solution quickly. We work with employers and recipients of awards. Please do call us to discuss.
How to award shares
Asking the correct questions
You will be thinking along the correct lines by considering the following.
1. Extent of participation
Employers need to decide who do they want to provide the benefit to? Many HMRC approved plans, e.g. EMI, can be granted on a selective basis.
2. How much equity to give away under the employee share incentives?
The choice on how much to give away rests with shareholders. We prepare share capital tables to show the shareholders the dilution under the share scheme. If employees leave usually they will lose entitlement. The shares surrendered by former employees can, if that is desired, return to the pool to provide for new awards.
3. What performance conditions, if any, will apply to the employee share incentives?
There is plenty of discretion on this point and no legislative requirements.
4. When will the options become exercisable/convert into shares?
You need to decide what happens on:
- Reaching milestones: for example, years of service, financial targets; etc;
- Sale of the business;
- De-merger of a business stream;
- Voluntary arrangement/administration order.
5. What happens if an employee ceases to be employed?
Should special provision be made for death, injury, disability or redundancy – usually these decisions are left to the directors.
6. How much will the employees pay to acquire shares under the employee share incentive?
There are no fixed rules. Shares can be gifted for free, subject to tax. Linked into this consideration is should employee enjoy inherent value accumulated pre-award?
7. How will the shares be sourced for the employee share incentive?
There is a choice of newly issued which dilutes existing shareholders . Or, to avoid dilution existing shares can be used if shareholders are prepared to allow for a transfer.
For new share issues it is necessary to consider whether the directors have the requisite shareholder approvals to issue shares pursuant to the option/share awards.
If existing shares are being used it is usually necessary to consider the tax position of the transferors. Some companies link equity awards to share buy backs under which existing shares are cancelled.
8. Are the existing articles and/or shareholders agreement adequate?
The articles and shareholders agreement should cater for employee shareholders who may present different risks than that of the existing shareholder base.
- For example what will happen if an employee leaves? Do you need good/bad leaver provisions? This is an area where employers often make mistakes which mean ex-employees walk away holding shares.
- The employment contract is quite separate from any contract for equity. This means you can fire as an employee, but unless the corporate constitutional documents expressly cover the point, the employee or director will remain a shareholder.
- If you are going to force a transfer of shares on cessation of employment – how will the shares be valued? There are plenty of choices ranging from a valuation by the accountants to the ability to appoint an independent expert.
- What valuation method will be used? Again, choices are available.
- Will employee shareholders be treated the same way as investors and founders? Setting up a new class of shares for employee shareholders is often an answer.
Employee share incentive plan – risk with poor design
A badly designed share incentive plan gives away more equity than intended and does not enhance shareholder value. You risk demotivating employees and driving them into the arms of competitors, if you fail to meet their expectations.
Disaster areas in poor design of employee incentive plans
Known disaster areas can include:
- Lack of a share capital dilution table plotting the fully diluted position if all options and share rights are taken up.
- Failure to clearly spell out performance criteria and vesting.
- Failing to review the articles and shareholders’ agreement to make sure you obtain the requisite shareholder approvals.
- Missing the regulatory requirements under the Companies Act.
- Over looking the bigger picture such as what should happen if the business is sold.
- Not understanding the tax reporting and payment obligations.