26 Jul Employee Share Schemes – Golden Handcuffs or Golden Handout?
We are often asked to advise a Board or majority shareholder on arrangements to sponsor valued employees into acquiring a shareholding in a company. The specific reasons for employee shareholding arrangements can include succession planning, a reward for loyalty and the contribution of the employee to development of the business or as an alternative to more traditional forms of bonus remuneration.
The plan is generally to incentivise the employee to help maximise company profitability and receive a potential bonus by dividend and potential capital growth for the shares held. However, if not structured correctly, the intended golden handcuff can end up being a golden handout to an employee without strings attached.
So what are the key factors to keep in mind in contemplating such a scheme? In our experience, good schemes incorporate the following:
Control:
An employee share scheme is not the same as an arm’s-length share acquisition. The employee is generally granted a very small shareholding in a company with the potential for this to grow over time. However, whatever the expectations of the employee, this should not give the employee the right to participate at board level as a director of the company or at shareholder level in key decisions. While the employee may be consulted about the company’s plans, this is very different to them having a veto right on decision making, which can be an unintended consequence in closely-held companies. The importance of control for a majority shareholder should not be forgotten.
Incentivise them to stay:
An employee will typically be funded into its shareholding by financial assistance from the company. This can often be achieved through a loan from the company (which is repaid from dividends) or through payment of an incentive bonus (which is then used to fund the purchase of the shares). Under either option, everyone needs to be very clear what the position is in the event the employee becomes a “bad leaver”, including through resignation or dismissal due to a performance issue. In this event, the buy back arrangements for the shares and the price payable on exit should be very clear, and often at a significant discount to the initial purchase price. This provides a practical incentive for the employee to stick with the business through thick and thin.
Sweat the small stuff:
Employee share scheme arrangements need to incorporate important points of detail that go beyond that which might be found in a typical shareholding arrangement. This reflects the number of options available in providing employees with shares (from an issue of new shares to the transfer of existing shares), the financial assistance arrangements that are often at play and the tax implications of getting it wrong. Building a successful employee share scheme arrangement requires time and effort and a level of investment that reflects the strategic importance of the arrangement to all parties.
For further information on establishing an employee share arrangement, please contact Alfred Harford, David Moorman or Patrick Casey.