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Entrepreneurship Series Part 4: Employee Share Schemes

David Montegriffo
Senior Associate

In the 4th in the Entrepreneurship series, David Montegriffo takes a look at employee share schemes – rewarding loyalty and motivating employees.

Companies are constantly seeking ways to motivate their employees and improve staff retention. Beyond traditional compensation packages, companies often implement employee share plans and offer other similar perks to align the interests of employees with those of the company. The prevailing view is that giving employees a stake in the company’s long-term success will lead to a more motivated, loyal and engaged workforce. A sense of ownership among employees fosters increased commitment, accountability and initiative.

Implementing a share scheme requires careful planning, clear communication, and compliance with applicable laws and regulations. Schemes can be adapted to suit the needs of the business and will generally be dependant on the size of a business, its industry, and the possible tax implications. Some of the common schemes involve either: (i) a share purchase plan where employees are given the opportunity to buy shares in the company at a discounted price, (ii) a share option plan where employees are given the right to buy shares in the company at a fixed price (usually in the future), or (iii) an ownership plan where employees are issued shares in the company as part of their salary package.

From a structuring perspective, companies should consider the following matters when designing the intended scheme:

  1. Eligibility and Participation: The eligibility criteria for participating employees will need to be clearly defined. A scheme can be open to all employees or limited to specific categories (such as senior management or key employees). Eligibility for participation in a scheme is often based on an employee’s length of service.
  2.  Granting of Awards: The scheme should outline the process for granting options or share entitlements to employees. This includes specifying the number of shares (or options relating to shares) being granted and the purchase/exercise price to obtain the shares. It is likely that the granting of these entitlements will have certain conditions attached to them. For example, in order to encourage employee retention, it is common to include “vesting periods” which slowly release an employee’s entitlements over time.

Share awards are also often subject to one or more performance conditions which will be linked to the performance of the company over a period of years. Typical performance conditions which may be useful when planning the relevant criteria include:

  • value-creation/financial measures such as (i) targets relating to earnings per share, (ii) return on equity, (iii) return on capital employed or (v) EBITDA;
  • operational performance measures such as (i) improved market share, (ii) product service quality levels, (iii) inventory levels, (iv) safety records, or (v) environmental performance; and
  • market-based measures such as total shareholder return.
  1. Shareholder Rights and Restrictions: There will need to be clarity on the rights and restrictions associated with the shares being acquired. Participants in the scheme will need to be provided with information outlining voting rights attaching to the shares, dividend entitlements, and any restrictions on the transfer or sale of shares. It is also prudent for the scheme to address “Exit” scenarios such as mergers, acquisitions, listings or liquidations.
  2. Termination of Employment: The scheme should address what happens to any options and vested shares upon termination of employment. Plans of this nature would usually set out provisions for “Good Leavers” and “Bad Leavers”. For example, a participant may be designated as a “Bad Leaver” in cases where they cease employment and move elsewhere before the award has been released – under these circumstances it is likely that their share entitlements will lapse entirely. On the other hand, share schemes usually provide for circumstances where participants are designated as “Good Leavers” (such as injury, ill health, retirement, redundancy, etc) and will allow for at least part of the share award to remain in place.
  3. Taxation and Regulatory Compliance: It will also be important to consider any tax implications for both the company and the employees. Consulting with tax advisors is recommended to ensure compliance with applicable tax laws.

Employees are more likely to stay with an organization offering direct ownership in the business, especially given that the value of their shares or options tend to increase with time. This reduction of employee turnover (together with the associated costs of hiring and training new employees) can have significant benefits for a business. By structuring these plans effectively, companies can not only retain valuable talent but also enhance their attractiveness to potential high-quality applicants.

 

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