If you’re looking for real and lasting growth, we believe this is a great way to get there. Offering key employees equity in the business is an effective way to consolidate strong members of the team with your business ambitions for long-term growth. If you want your team to join you in thinking big, the solution is simple – give them something tangible to think big about!
Engage the right team members for business growth
You are not going to create significant value in a global company without having great people committed to your success. But the best people are expensive; if your business is still small, you might not be able to pay them what they are worth yet. But you may still be able to attract them by offering other incentives, which means sharing opportunities and wealth among your team. A simple but effective way of achieving this is by expanding share ownership beyond the initial owner(s).
Employee share schemes must be clear for everyone involved
A share scheme is a great way to make sure key employees are committed to helping you scale the business effectively. But remember that you are starting a long-term relationship with these people, so choose carefully.
Discuss the idea of share equity thoroughly with them before you commit. Make sure they understand what’s expected of them and what the legal and financial implications will be for them personally. If it isn’t a win-win situation, issuing growth shares can end up being a huge headache or at the very least a complete waste of time.
Ideally, you should have a shareholders’ agreement drawn up so that there are clear procedures for handling any issues that may arise.
How to offer shares to employees in Ireland
It’s important to remember that any generation of wealth has significant personal tax consequences in Ireland. Shares offered in this way constitute an emolument or salary and therefore would be subject to income tax. So what are your options?
1) Create growth shares for key employees
It doesn’t usually make sense to give employees a share of what you have already built up. Instead, you could offer them a stake in the future potential of the company. Rather than transferring a portion of the existing ordinary shares in the company, what we’re talking about here is creating growth shares (also known as hurdle shares or flowering shares). These are given to either existing staff or to new hires – the star players who will be essential to the growth of the business.
Whatever way you choose to set up a shares scheme in your company, make sure you conduct it in such a way that employees are rewarded for the future growth of your business.
Let’s say your company is currently worth €3 million, and you’ve tasked a new employee with enhancing the value of the company over a period of time to €5 million. In this scenario, you would create a new class of share with different rights attached. The existing shareholder(s) will have their ordinary shares, but these new shares may be issued to the existing shareholder(s) and the new share owners.
This means the new shares will only come to have a value in the event of the company being sold for more than the current value of €3 million. You are locking in today’s value as being 100% attributable to the existing shareholder(s) and creating a mechanism whereby growth over and above today’s value is apportioned between the current shareholder(s) and the incentivised employee(s).
The great thing about flowering shares like this is that they have no value at the moment you give them to the employee. That means they are not a benefit in kind and there is no personal tax liability. They will only have value if the target growth (the hurdle) is achieved.
2) Offer share options to key employees
Perhaps your situation is different from the above example, and you are already in the process of giving one final push for a sale. Let’s say the exit horizon is only 18 to 20 months away. If you’re bringing someone in to drive this sale for that period of time and want to incentivise them with shares, the best option is to give them the opportunity to acquire shares at a certain point in time – share options.
This works by fixing the market value today and when, at the exit point, the shares are worth more, the employee has the option to acquire shares at the lower fixed price. Then they can sell them off after the sale of the business, at the higher share price, and make a profit.
Tax-wise, there are two types of option schemes. You can either leave the shareholder with income tax exposure or take advantage of the Key Employee Engagement Programme (KEEP) scheme. KEEP allows the individual to pay Capital Gains Tax on the profit they made on the sale transaction. This approach means that the shareholder, while they do have to pay for the share they are getting, is only paying when they are exiting, which is helpful when avoiding cashflow problems.
3) Approved Profit-Sharing Schemes (APPS) and Employee Share Ownership Trusts (ESOT)
Some larger organisations use APPSs and ESOTs. These are major share option schemes that require advanced Revenue approval, which can be a lengthy and cumbersome process. The issue is that with these schemes, all members of the company have access to share ownership, meaning you can’t cherry-pick your key staff. This option tends to only be used by very large companies, where it makes sense for those at the top level as well as the bottom level of the company to have shares available to them.
Use growth shares to exit a business
Another scenario where I have seen growth shares used to good effect is where an existing shareholder leaves the business. Let’s say you and a business partner founded a company and you both hold shares in it. After a couple of years, your partner decides they don’t want to work in the business any more.
Because they are still a shareholder, you will be left in a situation where if you continue to work in and grow the business, your partner will benefit as much as you do, even though they didn’t put in any of the work. By creating growth shares for yourself, you’ll be able to benefit from any increased value in the business over and above the current value.
What to do if employees need to finance the share purchase
If you are offering shares that do have a value, the employee might not be able to afford them. In this situation, they could get a bank loan which the company makes repayments to via payroll. Alternatively, the company can provide the loan (in which case, the loan is a taxable benefit-in-kind and subject to payroll taxes).
You can also offer an Employee Share Purchase Plan (ESSP). This is a way for employees to purchase shares in a company through payroll deductions, sometimes at a discounted price. The discount allowed is normally 15% of the market value of the shares.
These options facilitate the employee’s ownership of the shares because they have technically paid for them, even though they have not taken on a liability for them.
Don’t forget your share reporting obligations
There are several year-end reporting obligations for employers who operate share schemes for their employees – whether they are unapproved share schemes or Revenue approved schemes. In certain circumstances, trustees have a filing obligation too.
The standard filing deadline for share schemes is 31st March following the year in which the activity arose (for example, returns in respect of 2022 activity are due by 31 March 2023) and there are penalties for failure to make returns. Find out more in our blog about Share Scheme Reporting (SSR) in Ireland.
Create a tax-efficient exit plan
You can help your employees to set up a tax-efficient exit plan in, say, 3 to 4 years’ time using the Entrepreneur Relief scheme (caveat: we believe this scheme may not be around forever, so this timeline may not be feasible, find out more in our blog about Entrepreneur Relief).
You can even organise an option agreement allowing the company to buy those shares back at the same price should the employee leave employment before the agreed period is up. This way you get a lock-in for 3 to 4 years, the employee benefits from Entrepreneur Relief, and you can avoid tax issues by financing the purchase of the shares with a bank loan.
Whichever way you choose to set up a shares scheme in your company, make sure you conduct it in such a way that employees are rewarded for the future growth of your business. Linking employee rewards to the value of the company is a great way to engage and empower your key players, and it also engenders long-term employee loyalty, which is a valuable resource these days.
