Have you ever considered offering key employees equity in the business? If you’re chasing real growth, we believe this is a great way to get there. Offering share ownership is an effective way to consolidate strong members of your team with your business ambitions for long-term growth. If you want your team to join you in “thinking big”, then the solution is simple – give them something tangible to think big about!
Business growth means having the right people on your side
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 and if your business is still small you might not be able to pay them what they are worth or doing so could impact your bottom line. You have to be able to offer 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).
Be clear about what’s involved
Allocating shares 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 thoroughly with them before you commit to anything – make sure that they understand what’s expected of them and what the legal and financial implications will be. 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. Consider getting a shareholders agreement drawn up so that there are clear procedures for handling any issues that may arise.
How to offer shares to employees
Of course, you can’t just give your employees shares without significant tax consequences. 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
It doesn’t make sense to give employees a share of what you have built up to date, rather you want to offer them the future potential of the company. Instead of simply transferring your own shares in the company, what we’re talking about here is creating “growth shares” – sometimes called “flowering shares”. These are given to either existing staff or to new hires – those 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 “ordinary” shares, but these new shares may be issued to the existing shareholder with a proportion given to the newcomer.
What you have achieved is that all of the new shares will only have 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 and the incentivised employee.
The great thing about shares like this is that they have no value at the moment you give them to the employee. That means no tax consequence and no benefit in kind. They will only gain value if the target growth is achieved (this is sometimes referred to as the “hurdle”).
2) Offer share options
Perhaps your situation is different from the above example, and you are actually in the process of giving one final push for a sale and the exit horizon is only 18-20 months. If you’re bringing someone in to drive this sale for that period of time and you want to incentivise them with shares, the best option is to give them the opportunity to acquire shares at a certain point in time. This works by fixing the market value today and when, in a year or so when the shares are worth more at the advance of the sale, you can give them the option to acquire shares at the low fixed price. This way they can sell them off after the sale at the higher share price.
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 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) Employee Stock Ownership Plan (ESOP) and Employee Share Ownership Trust (ESOT)
Some large organisations still use ESOPs 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.
Another use for growth shares
Another scenario where I have seen growth shares used to good effect is when an existing shareholder leaves the business. Let’s say you and a business partner found 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’re left in a situation where if you work really hard 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 growth in the business over and above the current value.
How to finance shares (if needed)
If you are offering shares that do have value, the employees might not be able to afford them. In this situation, we advise companies to either tell their staff to get a bank loan (which the company makes repayments to via payroll) or to provide the loan themselves (in which case only a notional interest amount is subject to BIK tax). Either option secures the employee’s ownership of the shares because they have technically paid for it, even though they have taken on a liability for them.
With Entrepreneur’s Relief, you can help your employees set up a tax-efficient exit plan for 3 to 4 years’ time. You can even organise an option agreement that states the company can buy those shares back at the same price should the employee leave employment before the 3 to 4 years are 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 buying of shares with a bank loan.
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. Linking employee rewards to the value of the company is a great way to not only incentivise your key players to work hard, but it also engenders long-term loyalty which is a valuable resource these days.