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Share Incentives: An Outline

Gifts of Shares
The company can gift shares (or sell them cheaply) to its employees. The advantages are:

• it's simple and easy for employees to understand what they're getting
• they have an immediate stake in the company
• tax benefits - provided there is no ready market for the shares, no national insurance is payable

The main disadvantage is that if employees get their shares at the start, this can cause difficulties if an employee leaves or fails to perform after receiving the shares. There are several ways to avoid this problem:

• employees can be required to sell the shares on leaving the company
• use an Inland Revenue approved scheme to encourage employees to preserve their tax benefits by keeping their shares
• under a Long Term Incentive Plan, executives can be set targets over a range of years which will lead to them receiving a number of shares related to performance

Share Options
The employee is granted the right to buy shares in the company at some time in the future, but normally at the current share price or at a discount to the current share price. Exercise of the option can be conditional on performance targets.

• share options in themselves are an incentive for the employee to see the share value of the company increase. Performance targets allow this incentive to be refined and directed at specific measures of the company's performance
• the employees get no equity stake in the company until the options are exercised. If the employee leaves beforehand or performance targets are not met, share options are never exercised and the employee never becomes a shareholder, thus avoiding the difficulties which can result when shares are gifted direct to employees and also avoiding any dilution of existing shareholdings
• no actual cost to the company

There do not have to be any disadvantages to using share options. If new shares are allotted to satisfy options this will dilute the current shareholders, but this can be avoided by recycling old shares through an ESOP (see below). For the employee, options are a one way bet - if the share value goes up they are worth exercising - otherwise they can be allowed to lapse.

Employee Share Ownership Plans/Employee Benefit Trusts (ESOPs/EBTs)
These terms are used to mean the same thing - a trust set up by a company to benefit its employees. The trust will acquire shares in the company which are then made available to employees.

• as well as acquiring newly issued shares, the ESOP can acquire shares from current shareholders when they might otherwise find it difficult to dispose of their shares, particularly for small private companies
• shares from the ESOP can be used to satisfy share options or to make gifts of shares (or sell them) to employees
• contributions to the ESOP (which can be gifts or loans) done properly, will be tax efficient for the company

Tax and Share Incentives - Inland Revenue Approved Schemes
If employees do not pay full value for the shares, they are exposed to income tax liabilities on the difference between that value and the amount (if any) they actually pay (and sometimes NIC liabilities arise and PAYE has to be operated).

But these liabilities can be reduced, delayed or avoided altogether if an Inland Revenue approved employee share scheme is used. The following types of approved schemes are now available:

Save As You Earn scheme: All qualifying employees in the company are granted options. The exercise of options is funded using a special savings schemes which pays tax free bonuses

Company Share Option Plan: The company has discretion over which employees are granted share options, which can only be exercised every three years

Share Incentive Plan: All employees in the company are given either free shares, or pay for shares out of their pre tax salary or do a mixture of both. The shares however have to be retained for five years to maintain all the tax advantages

Enterprise Management Incentives Scheme: All or only certain employees in a qualifying company can be granted options with a value of up to £100,000 per employee which can be exercised at any time.

key expertise:

Roger Blears
Partner
roger.blears@martjohn.com