Employee Incentivisation – taking stock of your top talent

Going into 2020, few businesses will have been thinking too hard about employee incentivisation and remuneration beyond the activity they already had underway. Most schemes incorporate some form of bonus and pay review structure which will mean that ultimately the wage costs of the business will increase, but it will also ensure that good people are retained.

There are few businesses who haven't been impacted by the global Covid-19 pandemic and unfortunately, given the impact on the UK economy, it's going to be a tough road ahead for years rather than just months. Businesses may not be in a position at this point to commit to increased wages and bonus payments.

Despite all of this, businesses need strong teams, and strong key players, to maintain and grow the business. They will need to ensure that they don't lose their valuable key players, particularly when they may not have the budgets to offer increased pay, benefits or bonuses.

Shares and Business Equity

In these difficult times a realistic alternative may well be to offer employees shares and/or business equity. This offers more than just an immediate performance boost as a result of a bonus; rather it offers an employee the opportunity to become truly invested in the future of the business. Suddenly, winning or losing a deal or opportunity has an impact on their own longer-term financial reward. In the current economic climate, it's probable that many share valuations are lower than usual, so shares and/or equity offers even more of an incentive if there is an expectation of likely gains in the near future and beyond.

Allotting shares

It can feel counter-intuitive to hand out shares when the economy is in such a difficult place but there is a benefit to doing so. There are some things to consider if you decide to do this:

• There may be some tax implications that require investigating depending on the status of the recipients.
• If a business does decide to allot shares now, they need to ensure that the Articles of Association of the company are updated to ensure the employee owned shares are bound by specific restrictions.
• Any business considering allotting shares to employees needs to consider, among other issues, whether they will be able to recover those shares if the employee leaves, at what price and whether any voting rights attached to the shares should be restricted.

We would always advise that an employee shareholder should be required to transfer their shares back in the event that they cease to be an employee for any reason whatsoever. The way that the buyback provisions are structured will also need careful consideration as it may not be as straightforward as providing that the company should buy them (specifically, if the company is loss making and has no retained profits) although the Companies Act does now allow companies to undertake small exempt buybacks of small numbers of shares.

When issuing shares to employees, the company and the employee need to consider the potential tax consequences. If the shares are allotted at less than market value, the value of the shares (or the amount of the undervalue) will be taxed as employment income in the tax year in which the transfer is made and the employee will be liable to pay the income tax charge through PAYE together with associated National Insurance Contributions. This may result in a significant cost to the employee which they may not be in a position to satisfy and will often make a straightforward issue of shares unattractive.

An alternative we often advise on involves businesses putting in place Growth or Hurdle Share schemes for the benefit of the employees. Growth and Hurdle Shares allow the holders to benefit only from the growth in the value of the Company after the date of issue. The shares (usually) have no value at the point they are allotted and so there is no income tax charge at the date of allotment. If a company is currently valued at £5million the holders of the shares will only participate in an increase in value over £5million and hurdle shares only participate in growth above a 'hurdle' which is higher than the current valuation. The main advantages of Growth and Hurdle Shares are that:

• Their market value is much lower than that of an ordinary share which makes it much easier for an employee to invest;
• For an existing shareholder they retain their share of the current value of the company and are only diluted to the extent that there is future growth.

All of the issues in connection with employees having an interest in shares would be relevant and the Company would need bespoke articles to reflect the rights attributable to the growth or hurdle shares. Valuation of the growth shares is critical to the success of their issue and is dependent upon the current value of the Company. A specialist valuer will be needed for the valuation of the growth shares and records kept which can be produced to HMRC in future if needed. It is important to get professional advice before introducing growth or hurdle shares.

A further option where a management buyout is under consideration would be to reorganise the existing share capital to create 'freezer shares' from the existing share capital to 'freeze' the capital value attributable to the original ordinary share capital and then to create further classes of growth share in new percentages. This has the effect of ringfencing the value of the business for the existing shareholders while ensuring that the management team acquire the new growth shares subject to an agreed succession plan. It becomes an effective way to secure an exit for the original shareholders and can be very useful when other methods of funding are unavailable.

Share Options

There are two types of share option to consider:

• 'Exit only' which will offer the holders an interest in capital growth. 'Exit only' shares are often problematic as employees can consider that any benefit is entirely dependent upon a future sale of the business which they have no control over;
• 'Time and performance' which will offer the holders an interest in income and capital growth. They can be more successful as the employee can be given specific targets, which if achieved can enable them to exercise the option and potentially receive dividends derived from income in addition to a capital receipt on the sale of the company.

Share options can be a positive move not just for the employee being rewarded but also for the business, and are easier to implement as the recipients receiving share options won't get an interest until the option is exercised. This means that the employee doesn't have voting rights and the options usually lapse if the employee leaves the business, is made bankrupt or if the option isn't exercised within a specific timescale. Once exercised, the employee gets shares and pays less for them at exercise than their real value.

Although there are a number of possible options when it comes to establishing an employee share plan, and options can be issued with no tax advantages, we most commonly advise in connection with EMI schemes; the main features of which are:

• The business implementing them must have assets of ¬£30m or less;
• Limit of £250,000 of market value per employee in 3-year period
• No Income Tax or NI on grant or exercise if the shares are bought at market value; Income Tax and NI will be payable if shares were discounted to the employee on the difference between the price and market value
• Capital Gains Taxwill be payable on the difference between the sale price and exercise price
  Some companies are excluded from the scheme and 'excluded activities' include banking, farming, property development, legal services and ship building.

There are specific rules that apply to EMI schemes and so we would always advise a business to seek advice to make sure the desired scheme qualifies. Specifically, the valuation process needs professional support, particularly if the company is unlisted.

There is no way of guaranteeing that those who you consider your top talent will remain. It's a competitive market, even in a downturn, and individuals are increasingly seeking more than just a good salary in their employer. Employee experience, company purpose and ethical values are increasingly important to employees, although giving a stake in the capital growth of a company may well prove to be a prime incentive to stay.

Here to help you and support you

There is a lot more detail behind all of the above, so if you would like to explore the options available and find out if they will be suitable for your company please call us for further advice.

We will listen and get to the heart of the matter to achieve the best outcome for you.

For further information LCF Law's Corporate Law team can be contacted via telephone, email, Zoom, FaceTime and WhatsApp. Call us today on 0113 244 0876.

This article was written by Cathy Cook. Cathy is a Partner in our Corporate Department and is based in Leeds.

Her clients include owner managed businesses specifically suppliers into the large retailers for whom she has reviewed and drafted terms and conditions, framework agreements and outsourcing agreements.

You can contact Cathy 01132 384 042 or email ku.oc1701587929.fcl@1701587929koocc1701587929

Disclaimer: This blog is for general information and general interest only. It is not to provide legal advice on any general or specific matter, and no such advice is given. Should you like to discuss the points raised in this article, please do not hesitate to contact the author.