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Top 5 reasons not to implement an employee share scheme

Posted by Chris on October 31, 2011

Employee share schemes are not right for every company, but in many cases a share based incentive scheme is the obvious choice for attracting, motivating and retaining employees. They can also deliver major tax advantages. Yet sometimes companies hold back. Over the years we have found that the reasons for this are usually based on misconceptions. In this article we look at the top 5 reasons why companies don't introduce share schemes, and show that they are all based on misconceptions.

It's too expensive

Share schemes usually represent excellent value when compared with the costs of replacing employees or paying cash bonuses. In many cases, the costs are comfortably covered by the NIC savings alone, compared to other methods of remuneration. Other tax savings may be substantial and these may be available to the company and the existing shareholders as well as the employees.

Some practitioners, often with little experience in the field, offer employee share scheme advice at cut-price rates. Clients should be aware that the costs of incorrectly implemented schemes can be high. These include the loss of tax advantages and in many cases the imposition of penalties and interest by HMRC, not to mention the demotivating effects on the share scheme participants.

Loss of control by existing shareholders

Shareholders in private companies may be concerned about control, especially if there is a delicate balance between existing shareholders. However introducing a share scheme need not disturb the status quo. The rights of existing shareholders can be protected by making suitable provisions in the articles of association, and/or any shareholder agreement, in order to set out exactly how the company is to be controlled and by whom.

Alternatively, it may be possible to create a new class of non-voting shares for the purposes of the share scheme.

It is usually good practice to ensure that there are compulsory transfer provisions for any employee shareholders who leave the Company. This prevents shares drifting into the hands of unknown individuals, a situation which could cause difficulty as and when the company is sold.

In many schemes the issue of control never arises. For example, where a share scheme vests only on a trade sale, employees will sell their shares as soon as they acquire them.

Reluctance to accept dilution

The whole point of an employee share scheme is to make the value of the equity greater for all. This may be achieved by improving the motivation and retention of employees: by encouraging employees to focus on building shareholder value: by improving the tax-efficiency of the reward structure: or a combination of these. If a company is not confident that these benefits will outweigh the dilution, then a share scheme may not be appropriate.

Share schemes are often linked to performance targets so that employees receive no benefit, unless the targets are achieved and shareholder value is enhanced.

Share schemes are only for big companies, or companies with quoted shares

In fact the number of smaller private companies offering employee share schemes has mushroomed in recent years. Participants receive value for their shares when the company is sold or floated. Where no specific exit is planned, an employee benefit trust can be established to purchase shares from participants for cash. The shares are then usually recycled for further share scheme awards.

We often implement schemes for start-ups, or companies where there is only one employee. Even at this level the benefits and tax savings can be crucial. Implementing share schemes at an early stage in a company's development maximises the potential gain for employees.

Complexity

Most share schemes are simple in concept. Complications can of course arise in relation to the anti-avoidance provisions surrounding tax-efficient schemes. Complications can also arise in relation to a company's capital structure and articles of association; in relation to any shareholders' or subscription agreements; and in relation to accounting and valuation issues. However a competent adviser will ensure that these issues are properly dealt with and not allowed to impede the operation of the scheme.

Some companies decide to avoid the perceived complexities altogether by gifting shares to employees. This results in a charge to income tax at the highest rate and often to NIC payments as well. For large quoted companies there may be few tax-efficient alternatives. Smaller companies however should think carefully before making gifts of shares since there are several tax-efficient alternatives available.

If you have any other concerns about implementing an employee share scheme that we have not mentioned above please do not hesitate to call the office on 020 8949 5522 and speak to any one of the team who will be able to help.