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Five Key Reasons Why Companies Offer Employee Share Schemes

Posted on October 12, 2010

At RM2 we have implemented hundreds of employee share plans for companies of every size, in every sector of industry and commerce. Every scheme or option plan we design and implement is uniquely tailored to the precise circumstances of the client. Yet, when we come to look at the underlying reasons why companies offer equity incentives, a the same key reasons come up time and time again.

Here are the five key reasons that companies offer employee share schemes:

Motivating Employees

This may seem obvious, but why should shares be better than cash or other benefits? The evidence from a wide variety of studies indicates that share schemes work. The reasons vary. In some companies, the selective use of share schemes helps to align the interests of key members of staff to overall company objectives. In other cases, share schemes such as the Share Incentive Plan (SIP) help to change the culture so that everyone is encouraged to contribute. By giving staff a direct interest in their company they have a reason to care about how it performs. Employees become more motivated and the value of the company increases: a win-win situation.

Attracting New Staff

Nowadays, remuneration is not just about pay. Potential recruits are increasingly looking for what other benefits are on offer. Many companies now offer critical health, medical insurance and/or other benefits. An increasing number offer employer pension contributions. But many of our clients have found that these benefits don't get the same attention as an employee share scheme. If a share scheme is successful, it can offer the promise of significant financial gains in a relatively short period typically three to five years. This is a great deal more tangible than an insurance policy that may never pay out or a pension plan that may not mature for decades.

Tax Efficiency

All too often we come across companies who are paying out a fortune for bonuses and most of the money is going in taxes! Gains realised from share schemes are typically taxed much more lightly than salary or cash bonuses. The highest rate of capital gains tax is 28% while the highest rate of income tax is currently 50% (actually 60% between £100,000 and £112,950). Meanwhile, the lowest rate of capital gains tax is just 10%.

The comparison is made sharper by the fact that, on top of income tax, both employees and employers pay National Insurance Contributions (NICs): for employers, the rate is normally 12.8% (soon to be 13.8%). At these levels, the total tax burden becomes confiscatory and companies have little choice but to consider the alternatives.

Employee Retention

A key feature of many employee share schemes, particularly share option schemes such as the Enterprise Management Incentive (EMI), is that employees who leave will sacrifice all or part of the benefit. Most of our clients insist on these restrictions. This means that, as the benefits mount, scheme participants have all the more reason to stay and help build the company value for all shareholders.

In other cases, clients stipulate that the benefits cannot be crystallised until the participant has served a minimum loyalty period (typically 2 or 3 years) or specified performance targets have been achieved. The Company Share Option Plan (CSOP), a government approved and tax-efficient scheme, has a statutory 3 year minimum exercise period.

Succession Planning

Succession planning is a key concern for many private companies and shareholder/directors are frequently unsure how to address this issue. By using a share scheme, companies are able gradually to provide for members of staff to hold a larger share in the company and effectively begin to take control. Schemes that are particularly suitable for achieving this transition include the Share Incentive Plan and the Deferred Share Purchase Plan. Many of these schemes are implemented alongside an employee benefit trust, which can deliver large additional tax benefits in some cases without the need for aggressive tax planning.

If you think that any of these points could be relevant to your company and you would like further advice, please contact one of our advisers on 0208 949 5522 or email enquiries@rm2.co.uk.

 
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