Share and share alike:
the latest views on
equity-based
employee incentives
@KempLittle
#KLincentives
Andy Moseby
Amanda Solomon
David Williams
Martin Lewis
25 November 2015
Agenda
 The importance of employee incentives
 Ways of giving value to your employees
 Share and option awards
 Valuation and example
 HR issues
 How tech companies get it wrong (and how you can put it right)
 Q&A
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The importance of employee
incentives
The importance of employee incentives
 CIPD Report (Show me the money! The behavioural science of reward, 2015)
– Individuals have a subjective view of their own worth which varies over time
– Incentives need to be dynamic and flexible in line with employees’ expectations
– Need for fairness (consistency)
– Fail to value future reward so regular communication needed of value of deferred
incentives (such as shares)
– For executives, do bonuses promote short-termism?
 Consider both group and personal incentives
 Keep share incentives simple – not an incentive if participants don’t understand /
appreciate value
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Equity awards – initial issues to consider
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Tax and Cash
Management
Employment Law
Valuation and
HMRC
Commercial and
Corporate Law
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Ways of giving value to your
employees
Ways of getting value to your employees
Salary / remuneration
Employer NIC 13.8%
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Income tax and NIC
42% / 47%
Shares
Dividends
Capital
Income Tax:
Tax free / 7.5% / 32.5% /
38.1%
CGT 0% / 10% / 28%
How to give an equity stake to your senior employees
Equity
Tax advantaged
All Employee Plans
SAYE
Non-tax advantaged
Discretionary
Share Incentive Plans
EMI / CSOP Options
Discretionary
ESS
Shares
Fully Paid Up
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Unapproved Options
Nil Paid
HMRC statistics
Companies operating Share Schemes
14,000
12,000
10,000
Any
CSOP
8,000
6,000
4,000
2,000
0
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EMI
SAYE
SIP
What’s new in the market place?
EMI schemes remain popular
 Companies with higher market valuations
ESS schemes for the following:
 Private Equity backed companies
 Management buy outs
 Start ups
 Companies with lower market valuations
Growth share schemes / joint share ownership:
 Growth shares (growth from issue)
 Hurdle shares (growth above hurdle)
 Companies with higher market valuations
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Share awards
Types of shares awards
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Simple
Nil or partly paid
Growth
Gift
Shares – pros and cons
Pros
 Psychologically helpful because they are owners
Cons
 Financial risk – initial cash outlay for shares
 May participate in dividends
– nil paid
 Employees may want to see what other
– partly paid
shareholders see
 Simple concept
 May be interest relief on borrowings to acquire shares
 No EMI disqualifying events to worry about
– gift (taxable)
 Valuation is complex
– cannot agree value with HMRC before issue
– post valuation check is possible but discretionary
– valuation is complex
 Corporation tax deduction on issue of shares
likely to be less valuable than on issue of shares on
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exercise of an option
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Shares (including growth shares) – tax treatment
Income Tax / NIC
 Employment related securities legislation – 2003 –
very complex
 Income tax on acquisition of shares if pay less than
UMV (can have nil paid or partly paid shares)
 Subsequent tax charges if UMV not paid and
no election
 Can elect to be treated as paying UMV
 PAYE / NICs if readily convertible assets
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Capital Gains Tax
 Disposal of ESS shares can be free of CGT
 Otherwise, gain on sale of shares is likely to be taxed
at 28%
 Entrepreneurs’ relief available if, among
other things, shareholder holds at
least 5% of the ordinary share capital with at least
5% of the voting rights and remains employed
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Employee shareholder
shares
ESS taxation
Income Tax
 First £2,000 of ESS shares is exempt from income tax
and NICs (if no material interest)
 Shares worth >£2,000 are taxable on the excess
Capital Gains Tax
 Disposal of ESS shares (valued at up to £50,000 on
issue) is exempt from CGT
 No CGT relief if material interest (broadly more
than 25%)
 NB:
Valuation can be agreed with HMRC in
advance of issue
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 No exemption for inter-spouse transfers of
ESS shares
ESS – key features
Forego
certain
statutory
employment
rights
Must have
written
statement of
particulars
Cannot have
material
interest (25%)
ESS key
features
Issuing
company
does not need
to be
independent
Independent
advice must
be given to
employee
Shares in
employer or
parent
company
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7 day cooling
off period
The ESS process
Review reward
strategy and
consider
alternatives
Procedure
 ESS or share
schemes?
 Advice from
independent
adviser
 May be
relevant if EMI
qualification not
possible due to:
– size
– independence
– working time
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 Written
statement of
particulars
 7 day cooling
off period
Obtain HMRC
to ESS
valuation
 Strongly
recommended
 Full disclosure
required
 Helpful when
exit
Legal drafting
 Amend Articles
of Association
(if necessary)
 Statement of
particulars
 Employee
shareholder
agreement
 Advice on
becoming
employee
shareholder
(by independent
legal adviser)
Reporting
requirements to
HMRC
 Immediate and
ongoing
compliance
Sale of
Company
 Extensive due
diligence by
buyer
 Tax risks if
not properly
implemented
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Share options
Types of options
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Unapproved
EMI
CSOP
Combination
Unapproved options – taxation
Grant of option
 No income tax
Exercise of option
 Income tax on difference
between market value
(MV) and exercise price
Sale
Entrepreneurs’ Relief
 Normally no CGT because  Need 5% of
exercised on exit
 CGT on difference
 PAYE and employee NIC
between MV on exercise
 Employer NIC
and sale proceeds
voting power and share
capital
 One year ownership
requirement
 Rate normally 28% unless  Must remain employed
10% ER applies
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EMI / CSOP – taxation
Grant of option
 No income tax
Exercise of option
 No income tax
Sale
 Capital gains tax
Entrepreneurs’ Relief
 Do not need 5% of
assuming no discount
which is normally
voting power or share
at grant (EMI)
taxed at 28%
capital (EMI)
 No income tax if exercised  Capital gains annual
between three
and 10 years after
grant date (CSOP)
exemption of £11,000
 10%
Entrepreneurs’ relief
 No one year ownership
requirement (EMI)
 One year from date
of grant to date of
sale (EMI)
 Must remain employed
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EMI – company qualifications
Trading
company
£3 million
unexercised
options
UK permanent
establishment
Property
managing
subsidiaries
Company
qualifications
Qualifying
subsidiaries
Less than 250
employees
Independence
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Gross assets
£30 million
EMI – trading activities excluded
Land dealing
Legal and
accountancy
Selected
Share dealers
Excluded
Trades
Royalty /
licence fee
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Banking /
insurance /
financing
EMI – employee requirements
Employee of
company or
subsidiary
Working time
requirement
10 year
exercise limit
Employee
requirements
Unexercised
options limited
to £250,000
No material
interest (30%)
By reason of
employment
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The option process
Review reward
strategy and
consider
alternatives
Agree
performance
criteria and
other metrics
Obtain HMRC
as to company
qualification
Obtain HMRC
to EMI / CSOP
valuation
Legal drafting
Grant options
 Option
agreement
 Timing of
options
 Best practice
 ESS or
share option
 Discussion
with employee
group
 Scheme rules
 Helpful on exit
 Strongly
recommended
 Vesting dates
 Good / bad
leaver
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 Full disclosure
required
 Helpful on exit
 Articles
Reporting
requirements
to HMRC
Exercise
 Immediate and
ongoing
compliance
 Complex
issues
• May be part of
sale
Sale of
Company
 Extensive due
diligence by
buyer
 Tax risks if not
properly
implemented
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Synthetic share awards
Synthetic share awards – taxation
 Cash awards the value of which is linked to the value of the company's shares
 Often used by to grant awards to employees that mirror share options, in circumstances
where actual share options are not appropriate or possible
 Generally discretionary
Grant of award
Cash payment under award
 No liability to income tax
 Income tax payable on cash amount  Employee is awarded cash rather
paid out under award
 Income tax payable through PAYE
 NICs also payable
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Sale
than shares or other securities, so
tax on disposal is irrelevant
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Valuation and example
Valuation – the key driver
Drives decision-making process
• What is feasible?
Lower valuation
• ESS
• Shares
Higher valuation
• Options (EMI/CSOP/Unapproved)
• Nil/partly paid shares
• Growth shares
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Valuation process
Calculate
maintainable
earnings
Identify appropriate
multiple
Other market
transactions
Discount factors
 EBITDA
 Directors
transactions
 Risk
 Net assets
 Losses
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 EIS / SEIS
 Investor documents
 Minority
HMRC
correspondence
Example valuation [1]
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£150,000
£900,000
£180,000
£36,000
 Maintainable earnings
 Valuation using
a multiple of 6
 Pro rata value of 20%
 Valuation after taking
minority discount of 80%
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Example valuation [2]
 As above but:
– Company is new and currently loss-making with net assets of £100,000
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£0
£100,000
£20,000
£4,000
 Maintainable earnings
 Valuation using
Net Asset Value
 Pro rata value of 20%
 Valuation after taking
minority discount of 80%
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HR issues
What happens on termination of employment?
 Typical consequences:
– Unvested options lapse
– Vested options:
– Good leaver: can be exercised early/retained until they are exercised
– Bad leaver: lapse
Note potential timing considerations - Geys v Société Générale, London Branch [2012]
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Approach to good leaver/bad leaver provisions
 Good leaver:
 Injury/ill health/disability, death, [retirement], redundancy, transfer of business/group
company
 defining terms - eg redundancy
 potential for discrimination – age and disability
 TUPE – right to benefit from profit share or option scheme – MITIE Managed Services Ltd v French
2002
 A bad leaver is everything else
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Protecting the company from liability on termination
Micklefield clause:
"If any option holder ceases to be an executive for any reason he shall not be entitled, and by applying for an option an executive shall
be deemed irrevocably to have waived any entitlement, by way of compensation for loss of office or otherwise howsoever to any sum
or other benefit to compensate him for the loss of any rights under the scheme."
 Effective against wrongful dismissal but not:
 unfair dismissal claims - although compensation will be capped
 claims regarding discretion to permit the exercise of an option – Mallone v BPB
Industries plc [2002]
 discrimination and whistleblowing claims
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Penalty clauses
Cavendish Square Holding BV v EL Makdessi and ParkingEye Ltd v Beavis [2015]
• Is the provision a secondary obligation which imposes a detriment on a contract-breaker
out of all proportion to any legitimate interest of the innocent party?
• Is the provision penal?
• Are the means by which the contracting party’s conduct is to be influenced (that is by a
potential penal provision) “unconscionable or “extravagant” by reference to the norm?
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Employee shareholder status
 Employees give up certain statutory rights including:
– right to request flexible working
– right to a statutory redundancy payment
– right to claim unfair dismissal (subject to certain exceptions),
but not protection from discrimination and in relation to whistleblowing
 Some statutory rights are different such as they must give 16 weeks' notice (rather than
eight weeks) to the employer of their intention to return to return to work during the
maternity/paternity leave period
 Any shareholder status agreement will have no effect unless:
– the individual has been given written particulars and receives independent advice on terms and effect of the agreement
– 7 days have passed since the date that he receives that advice
 Employees who refuse to accept employee shareholder status have enhanced protection
from dismissal
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How tech companies get it
wrong (and how you can put
it right)
How tech companies get it wrong (and how you can put it right)
 Was exercise price less than market value?
 Issue EMI options once HMRC confirms the valuation (12 months rule)
 Issue EMI options prior to receiving an offer (otherwise valuation pegged to offer value)
 Provide for options exercising prior to a sale
 Consider an option audit well in advance of a sale
 Synthetic shares awards (financial promotion / financial assistance)
 Get it right, as rectification after the fact is difficult:
– Prowting 1968 Trustee One Limited and others v Barry Amos-Yeo and Kevin Amos-Yeo
[2015] EWHC 2480 (Ch)
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Q&A
Contact us
Andy Moseby
Corporate Partner
+44(0) 20 7710 1650
andy.moseby@kemplittle.com
Amanda Solomon
KEMP LITTLE
Cheapside House
138 Cheapside
London
EC2V 6BJ
Head of Tax
TEL
FAX
+44 (0) 20 7600 8080
+44 (0) 20 7600 7878
—
kemplittle.com
+44(0) 20 7600 8080
amanda.solomon@kemplittle.com
Martin Lewis
Tax Consultant
+44(0) 20 7600 8080
martin.lewis@kemplittle.com
David Williams
Head of Employment
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Kemp Little LLP is a limited liability partnership registered in England and Wales (registered number: OC300242) and is authorised
and regulated by the Solicitors Regulation Authority. Its registered office is Cheapside House, 138 Cheapside, London EC2V 6BJ. A
list of members is open to inspection at the registered office.
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