Employee Share Schemes

What use is an employee share scheme?

Employees are often the single most important factor in a company. How do you let them share in the rewards of their endeavours, ie. the increase in company value? Bonus and incentive schemes work to a point but sometimes you may want to offer key employees “a piece of the action”.

How can you reduce your financial commitment in a company, possibly providing a step in a potential exit strategy for you?

What are the issues that need to be considered when establishing an employee share scheme?

Here are some pointers.

Features of an employee share scheme

Schemes generally provide a positive incentive for employee involvement in running a company, can ensure an employee's long term commitment to the company and provide a financial incentive by sharing in growth in company value.

Success depends heavily on each employee’s perception of the scheme’s value. Employee shareholders need to see the value of their shareholding and any increase, or decrease, in value.

The rate of participation in a scheme is likely to be determined by the terms of acquisition and the degree of confidence held by employees in the profitability of company

There are various schemes which may be considered:

• General schemes where shares are offered to all employees after a specified period of employment.
• Schemes where share options are issued.
• Phantom share schemes where shares are held in a trust in which employee’s beneficial rights are divided into units.
• Top hat or executive schemes where shares are restricted to senior management.

Determine whether participation is to be offered to senior management, key employees or all employees.

Entry and exit price may be determined by various methods including the net asset value of the company, an annual share valuation by an independent party or a formula based on earnings streams of the company.

Consider methods for funding employee share purchases – deferred payments, applying dividends in payment for shares, etc.

A process for buy-back of shares on retirement, death, dismissal or redundancy is crucial.

A shareholding threshold may govern entitlement to a directorship.

Unless the company is listed on the stock exchange there is likely to be a limited market for the shares. This could partly be overcome by having the company offer to repurchase any shares on predetermined conditions.

There are compliance issues relating to the Companies Act, Securities Act, and Income Tax Act.

As an incentive or bonus remuneration, a properly structured bonus/incentive scheme may be a better method. There may however be a higher cash cost in paying a bonus.

There are potential pitfalls in employee share schemes. Employee shareholders should contribute to the decision making of the company – however great care needs to be taken to ensure such schemes do not inhibit the decision making of the company. Who will control the company?