Usually, companies implement an LTIP, Long Term Incentive Plan, for senior executives whose planned awards fall outside of the permitted maximum of an HMRC approved share plan.
Our LTIP services include:
We establish your objectives. Then, we tell you what is best for meeting your objectives and why. We prepare the legal agreements, deal with shareholder approval and provide practical implementation support.
LTIP – How to achieve the best plan
The basic idea behind a LTIP is that participants receive share options or shares if they satisfy certain performance criteria over time. Sometimes, the LTIP participants have to invest a proportion of salary or cash bonus towards the acquisition of shares.
Operation of a typical LTIP
Most LTIP’s operate as follows:
- An Employee Benefit Trust, administers the LTIP and secures the shares, then:
- Distributes shares or options to employees, who satisfy the terms and conditions;
- The board selects the participants and terms;
- The board sets out the performance criteria for senior executives;
- Non-executive directors and consultants are usually excluded from participation;
- Often shareholder approval is required;
- The design of the LTIP determines the timing of the tax payments;
- There is often a retention period, usually between 3 to 5 years, between when the performance criteria are met and eventual pay out.
LTIP: determine the award
LTIPs are flexible. For each participant under an LTIP, the board determines the:
- Size of the award;
- Type of award;
- Price paid to acquire shares;
- When options can be exercised.
Performance criteria under an LTIP
The pay out from the LTIP depends on performance targets linked to the company’s growth metrics. Increasingly performance targets include soft or behavioural components to promote the culture of the company.
LTIP: key features
Usually LTIP share awards feature:
- In private companies only: separate share classes for employees and/or directors.
- Shares then possess different rights, e.g. for income, voting and capital, to those held by e.g. investors.
- Relatively low acquisition cost, e.g. par value.
- LTIP dilution limits where the existing shareholders cannot be diluted without limit by LTIP shares.
- Employer fixes the value at which shares return to the employer, when employee or director departs.
- The articles or shareholders agreement defines the shares rights;
- Share issues can dilute existing shareholder’s shareholdings. However:
- Existing shareholders can transfer their shares to employees, if
- Existing shareholders approve.
LTIP malus clauses
Financial misconduct is often discovered after the fact. Those involved might have left with their pockets full or they may expect an LTIP pay out after the end of the retention period.
The employer company can recover the award under an LTIP if permitted by the LTIP rules, under:
- Claw back provisions – the participant will have to repay if the performance of the business is not as good as initially reported;
- Malus provision – the LTIP award can be adjusted downwards to reflect a change in circumstances.
When malus and claw back clauses are used
Malus and claw back are increasingly common in LTIPs. They usually apply in these circumstances:
- Misconduct by the LTIP participant;
- Bad risk management by the LTIP participant (typical in banking and insurance sectors);
- Misstatement of financial records;
- Wrongful assessment that the performance criteria have been met by the LTIP participant.
Regulated companies, especially in the financial sector, are required to have a claw back or malus period of up to 10 years. Typically, a three year period is considered.
Executive directors challenge malus and claw back
Usually, executives want a high proportion of their pay to be fixed pay. They do not want any part of their pay to be refundable. Executives will typically challenge malus and claw back:
- When the director’s service agreement is negotiated to exclude any malus and claw back clauses;
- After termination, when malus and claw back are enforced;
- Bonus and LTIP disputes damage the company’s reputation. They scare off potential new hires. The aim is to prevent disputes before they happen. We draft independent expert clauses in LTIP rules. We are mindful of the desire to keep the LTIP disputes out of the public eye.
Taxation of LTIPs depends on the nature of the award. LTIPs can be taxed as:
- A bonus paid in shares and taxed as income from employment;
- A share option – depending on whether the option is approved (CSOP), or unapproved, capital treatment may be available.
LTIP: holding shares in an Employee Benefit Trust
Most companies which operate LTIPs hold LTIP shares via an Employee Benefit Trust (EBT). An EBT provides an internal market for shares which makes the LTIP very attractive for employees:
- EBT buys the company’s shares; and
- EBT distributes shares to the employees;
- Shares are held on trust by the EBT.
The tax treatment of transactions made via the EBT have been the subject of recent anti avoidance publicity. Care will be taken to plan for tax exposures.