Capdesk Insights: Pett Franklin & Co LLP On Setting Up An Employee Share Plan

Share plans are one of the most important things a company can do to recruit, retain and motivate its staff. A properly managed share plan can align employees, managers and shareholders to work together to achieve the company’s financial and strategic goals. But – occasionally – they can also go wrong. So what should you think about when setting up a share plan? And what should you avoid to prevent problems?


Your New Share Plan – What You Should (and Shouldn’t!) Do

 

1. Start with the end in mind

Giving your employees any sort of share-based incentive will inherently work to some extent in aligning them with the shareholders’ goals. As the company gets more valuable, they get a share in it – so they should be working to maximise that value.

But “make the company more valuable” can be a fairly diffuse goal. What do you want your employees to be thinking about in order to get you there?

“Their jobs” is an obvious answer, but only gets you partway – the point of share awards isn’t to get your employees to work to rule. For senior managers, you might want to reward specific business objectives. For wider share awards, if your employees can put their own work in a wider context, and understand how it fits in with the business’s overall goals, you’re likely to see much-improved performance.

So make share plans part of your strategic planning, and set performance conditions accordingly.

And for private companies, think hard about how your employees are going to realise cash from their shares down the line – especially if an exit in the form of a sale or IPO isn’t on the horizon. Even if it is, think about what might happen if it takes longer than you expected to get there.

Shares in your employer aren’t – and employees shouldn’t see them as – a short term investment, but if employees can’t see any prospect of realising their value, their real worth to an employee is inevitably less than it might be.

 

2. Options or direct share awards?

Instead of giving employees shares in the company, you can give them options – rights to acquire shares in future. You might even be able to do so with the benefit of tax relief under a statutory share plan such as “EMI” or “CSOP”.

This can be much easier to administer than giving your employees actual shares from the outset. For example, if an employee leaves, you can simply cancel their options rather than needing to go through a formal buyback or forfeiture procedure for shares. You can also avoid the administrative overhead of circulating resolutions and other shareholder documentation to employees with small minority shareholdings.


However, your employees will also lose out on the chance to receive dividends – and “real” shares can be more meaningful to employees, in terms of letting them feel they have a stake in the business.



3. What do you want to give your employees, and what should they have to buy or earn?

Many share plans operate on the principle that employees should get a share in future value – not value which has already accrued within the business. However, employees will often be given that share in future value without any upfront cost.

For example, take a market value share option. Employees won’t need to pay anything until they exercise the option (which they aren’t obliged to do), so there is no upfront risk or cost. However, employees will only benefit from the growth above the current “market value” of a share, so will not get any of the company’s value which has already accrued to date.

This is probably the most common form of share incentive, and strikes a balance between reward and risk for the employee. But this isn’t going to be right for all situations.

For a long-standing employee, you might want to gift them part of the existing value – this will often need more thought around the tax charges which will arise, but can certainly be done.

Alternatively, you might want to ask employees to buy shares outright. This is riskier – do they have the money? will the share price rise or fall? – but gives them, in literal terms, a very real investment in the company. Of course, this can be made easier by paying employees a bonus to reinvest in shares, or by using a structure with statutory tax relief such as a SIP.


4. Make sure you get value in exchange for giving it away

So, you’ve made share awards. If your employees stay on for another three years, or five years, and any performance targets are met, they can expect to benefit alongside you from the company’s growth.

Do they know that?

It’s a real question! Your employees will have needed to sign up to some sort of grant document in order to receive their awards, and they should have some understanding of what that means. But if the options are granted and then forgotten about, it’s likely their incentive effect is going to fade.

To maximise the benefit from your share plan, your employees should be kept informed about the company’s performance and the potential value of their awards. What they own needs to have real value to them. Otherwise, on vesting, you can find yourself giving away part of the company’s value without having received the benefits of improved motivation and performance from your employees in the meantime.


5. Think about the future, not the present

How much are your shares worth right now?
If your company is still in a development stage, the answer might be “very little”. Even for a larger, well-established company, a small shareholding in the hands of an employee might have a very low value on its own.

But if you want to give your employees significant value right now – pay them a cash bonus instead. A one percent shareholding (or even less than that) might not be worth much now, but shares are a stake in the future of the company.

So think about what you’re trying to achieve in five years, and make share awards with that in mind. Talk to your employees about what your goals are for the company, tell them how much their shares will be worth if it succeeds, and work together to make it happen.

And remember to keep track of how many share awards you’ve actually made, especially if you’ve granted options rather than giving out shares directly – a few small awards to key employees can add up quickly as the company grows.


6. Don’t wait too long

Setting up a share plan can be difficult and time-consuming. We try to make it go as smoothly as possible, and issues can be minimised by setting clear objectives and working to an agreed timetable – but it still takes time and thought from the directors to make it happen.

So it can be easy for share awards to get delayed and put off. Ironically, this can sometimes happen more easily in well-run companies – the business is doing well, everyone’s working to capacity, and key employees trust the owners to look after them and follow through on their promises.

But this is storing up real problems for the future. The more the company grows, the more difficult it becomes to make share awards without significant tax costs – especially for your longest-serving key employees, who may have a justified expectation that they’ll get part of the value they’ve helped to build up.

Share plans work best when implemented early – and while it’s not always practical to set one up immediately, it can be very expensive to leave it too late.

7. Get the detail right

This should be the easy part when you’re first setting up a share plan – your advisers should get it right for you!

But take it forward a few years – let’s say your company is being sold. In the meantime, you’ve made regular share awards most years, some of which have vested, others of which have lapsed. Maybe you’ve let some employees exercise options and acquire shares already.

And let’s say in the meantime, you’ve had some personnel turnover, and the person who originally took care of all the documents and administration for your share plan isn’t around anymore.

In this situation, it can become a serious issue quite quickly if you can’t demonstrate that all your awards have been made correctly, tax deducted properly, and you know exactly who gets what now. This isn’t too difficult if you keep on top of it, but trying to reconstruct everything that’s happened and evidence it to a buyer, among all the other stresses of a transaction, can become much harder than it needs to be.

So setting up procedures now, and thinking hard about when you might need professional support in future, can make life much easier and save money down the line.

 


 


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Pett Franklin is a specialist law firm providing a uniquely integrated legal, tax and accounting service for all forms of employee share schemes and employee ownership to quoted and unquoted companies of all sizes across the UK. We also undertake share valuations, provide sophisticated financial modelling and advice on the accounting treatment of equity based awards.

 

Charlotte Fleck
Charlotte Fleck

Associate at Pett, Franklin & Co LLP