Shares or share options are well known ways to incentivise employees and care is needed to review the tax considerations for these. However, this is far from the only consideration needed when looking at the best way forward for a family business.
It is quite common for the main shareholders of a private business to have conflicting emotions when incentivising key staff. On the one hand they understand the benefits of long term incentivising by offering equity in a company. However it is common for key management not to be members of the family which own the business and therefore there can be resistance to allowing shares to be offered to “outsiders”.
The psychological dilemma can be partially overcome by issuing phantom shares or share options. Phantom shares are bonus arrangements (subject to PAYE and National Insurance) which provide management with the same level of income as if they owned shares but without actually issuing them with shares. This allows management to feel that their efforts are rewarded without the owners giving away any of the business. Our clients have used these arrangements however, as payments are through the PAYE system they can be expensive for the employer.
Share options can be used to overcome the dilemma about loss of control by the family. We have had clients who have not been keen on issuing options for this reason. Their concerns have been alleviated when we point out that options can be granted which only vest on certain criteria eg on sale. This therefore allows the family shareholders to retain control until such time as there is an exit event. At that point the management participate and their hard efforts leading up to the sale can be rewarded.
Enterprise Management Incentive (EMI) options are the gold standard of option as they allow the option holder Entrepreneurs’ Relief in most cases and most of our work is aimed at issuing EMI options where they are possible. There are various criteria attached to EMI options which need to be considered, including that the option must be capable of being exercised within ten years of grant. Occasionally there are discussions between shareholders and management about quantum of options offered to management. If it is over a fixed number of shares then management may have concerns that subsequent share issues would dilute their entitlement.
If the conditions attached to EMI cannot be met then a Company Share Option Plan (CSOP) may be appropriate. This can be used by any company regardless of its type of trade or size. This type of approved option has a £30,000 monetary limit on the value of equity per employee with the requirement for the options to be exercised within three and ten years of grant. These conditions are less attractive than EMI and make it more difficult to use them for exit planning.
Given the restrictive conditions and the lack of immediate entitlement to Entrepreneurs Relief, CSOP is considerably less popular than EMI. However in the right circumstances they can be used to attract key personnel as options can be granted on a selective basis and provide golden handcuffs to existing key personnel.
In conclusion many Entrepreneurs understand the benefit of providing equity incentives to key management. Some individuals do not wish to offer shares to management as it can dilute the family’s interest in a business. Share options can be used which are granted on a selective basis and exit-only. This can be used to bridge the conflicting desires of management incentivisation with perceived loss of family ownership.