The final Employee Ownership Explained webinar in the current series discussed share schemes within the EOT business. This was a topic much requested by previous attendees and we were lucky enough to have speakers Rodger Cairns and Gavin Charlton from Shepherd & Wedderburn who are very experienced in this field and this made for an excellent, informative session.
You can view the recording of the webinar below.
Rodger began with a challenge: if share schemes are expensive and time-consuming, then why do companies implement them? His view is that in an employee-owned company, where there is already a commitment to employees having a (albeit indirect) stake in the company, a share plan allows more flexibility for companies to attract, incentivise, reward and retain the employees who may be the key drivers of the firm’s future success.
Rodger explained that the share schemes work by incentivising employees collectively, i.e. by enhancing share price, as well as on an individual level i.e. by setting performance conditions. Overall, direct share ownership provides a clearer alignment of individual interests with business goals. Having said that, cash-based incentives can work well, usually being easier to implement and administer on an ongoing basis.
Rodger and Gavin ran through the main types of share incentive schemes, clarifying that they fall into two broad categories; option plans which give a contractual right to acquire shares at a later date, and upfront acquisition schemes where individuals gain a share interest at the outset.
The most popular plan is the Enterprise Management Incentive, largely due to the generous tax advantages and the high thresholds available. Gavin gave a deep dive into how these worked. Helpfully, Gavin talked through a worked example of how an EMI might operate, and how the benefits to the employee, and the costs to the company, compared to a simple cash bonus and also an unapproved scheme.
Why should an EOT company consider a separate share plan? In Rodger and Gavin’s view, a share plan provides an additional mechanism which takes employee participation a step further. Often the offer of a share holding is an effective tool for recruiting high calibre staff, and all serves as a powerful retention tool in retaining star performers. If introduced early in the EOT journey, the scheme can be linked to the repayment of any deferred consideration, which ensures focus on generating sufficient cash to pay promptly.
Rodger also touched on the Share Incentive Plan which is an all-employee scheme i.e., all employees must have the opportunity to participate and this often fits well with the ethos of the EOT company. Growth shares were explored, and this plan is often used by companies that are not eligible for EMI schemes. Both the Share Incentive Plan and Growth Shares are examples of upfront acquisition arrangements rather than option plans.
Gavin and Rodger summarised with some advice on how to implement an effective share scheme. They stressed it’s important to invest time at the outset, considering carefully the objectives and the pitfalls to avoid. It’s always good to keep it simple and communicate well; if the employees don’t understand the benefits, it won’t act as an incentive. It’s important to maintain focus on the plan with continual communication. Importantly, treat leavers consistently and beware of any potential breaches of employment conditions.
The session ended with some predictions of what might come out of the current consultations issued by HMRC. One is specifically referring to share schemes and the other consultation considers EOTs and EBTs (Employee Benefit Trusts). The time period for notification to HMRC of the grant of EMI options will be extended. The potential changes to the EOT legislation could be tighter rules around the composition of the Trustees, and a requirement for the Trustee to be UK resident. There is also a possibility that the rules around bonus provisions may be amended. It is hoped that one of the outputs is clarification that the EOT contributions are not treated as distributions from the company, and not subject to tax.
All agreed it was a superb session, and as there was no time to ask all the questions, these are included below.
The full webinar presentation can be viewed here: Recognition & Reward – Share Schemes within the EOT Business 21.11.23
Question and Answers
Q. Is the £30m gross assets threshold for the grant of EMI options set in stone?
A. Yes, at the time of the grant the company’s gross assets must be less than £30m. If this threshold is breached at a later date, there is no impact on existing options, but the company is unable to offer further grants of EMI options
Q. Can Phantom Shares run in parallel with the EOT and thus reduce the risk of breaching the controlling interest in the EOT?
A. Phantom plans definitely have their place, particularly where people are looking to get the benefits of share participation without the hassle. The obvious downside is that a phantom share plan is just a cash bonus plan, and you are forgoing some of the tax advantages that might come with an approved plan.
Q. At which point in the EOT journey is it appropriate to consider a share scheme?
A. There’s no set answer for this. You see some transactions where there is a drive to grant options at the same time as the transition and there’s a couple of reasons for that e.g. you may be able to agree a low value with HMRC if there’s a lot of deferred consideration that has to be funded by the trading company. Also, the vendor might be reassured by having the incentive in place to focus on generating the cash to pay the deferred consideration.
In other transactions, the EOT project presents quite a distraction and some companies prefer to focus on getting that over the line, and then look to implement a share scheme either soon after completion or at some time in the future.
All companies operate under different constraints and circumstances and it’s important to be as clear as possible at the outset in order not to exclude any possibilities in future.
Q. How much admin and record-keeping is involved in implementing and running a share scheme?
A. That depends. Offering a straightforward scheme to a small number of executives requires minimal effort whereas a complex scheme offered to a wider group with varying rules and performance conditions can be quite cumbersome. It is possible to outsource this work to share scheme specialists and costs for this have come down in recent years.
Q. Is there evidence that a share scheme alongside an EOT enhances the performance of the company more than the introduction of an EOT on its own?
A. Anecdotally, in my experience share plans work very well at delivering value for the company and for the individuals. And of course, if the company is more successful because of this, all of the EOT beneficiaries benefit from working for a more profitable, well-managed business.
Q. On EMIs, can you explain discounting?
A. The rules allow the company to grant EMI options with an exercise price that is set at a discount to the market value of the shares at the time of award. However, any such discount will be chargeable to tax at the point of exercise. This is why it’s important to agree a valuation with HMRC before the grant of EMI options.
Q. Gavin said that there are issues with granting EMI options where certain types of Corporate Trustee are involved. Does this prevent companies with Corporate Trustees from implementing EMI options?
A. This reinforces the need to think carefully of what any future plans might be when implementing the EOT transaction. It is quite a technical point. EOTs are commonly set up with a Corporate Trustee. This Corporate Trustee is typically a company that the trading company sets up for this purpose. If this trustee company is set up as a company limited by guarantee then there can be problems meeting the EMI “qualifying subsidiaries requirement”. Consideration may be given to setting up the Corporate Trustee as a company limited by shares if EMI options are to be offered.
Q. If the EOT bonus is paid equally, can it be adjusted for hours worked (i.e. part timers) and new joiners?
A. Yes, the rules allow the company to pro-rate the bonus to hours worked and to set a qualifying period for eligibility to receive a payment.
Q. Can an EOT issue an EMI scheme over the shares it holds or is it better to issue additional shares as long as it does not reduce the EOT holding to below 50%
A. It would usually make more sense for the company to grant options over its shares rather than using shares in the EOT. The EOT’s interest would be diluted so care needs to be taken to avoid it losing control. Having the company grant the options over new issue shares avoids contravention of the equality requirement in EOT legislation, and is also more tax effective.
Rodger Cairns, Partner, Shepherd & Wedderburn
Rodger (qualified in 1997) heads up the practice and provides advice on all aspects of employee share participation to a broad range of listed and private organisations. Having previously been head of Ernst & Young’s Performance and Reward Practice in Scotland and Northern Ireland, he continues to have a particular interest in wider executive compensation issues and regularly assists clients on corporate governance matters.
The team has been top-ranked by Chambers for many years and Rodger individually also received a “Star Individual” ranking from Chambers.
Gavin Charlton, Director, Shepherd & Wedderburn
Gavin qualified into the team in 2009 and over the past 14 years has worked exclusively on employee share schemes for all sizes of clients, from small private start-up companies to FTSE100 companies. He has extensive experience of share plan design, implementation and operation including providing ongoing, practical assistance in such areas as grant process management, performance condition monitoring, participant communications and treatment of leavers. Gavin also provides support on share plans and executive compensation to listed company Remuneration Committees and to private companies transitioning to employee ownership.
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