Share incentives: navigating the dead zone for small PLCs
The importance of equity incentives seldom diminishes as companies grow in size. For those companies making the transition from limited company status to PLCs, there are special challenges in relation to share based incentive schemes.
Why do these arise? Generally the regulatory regime, including the Companies Act 2006, is tougher for PLCs than private companies. Here are some of the regulatory issues that can be relevant for share incentive schemes:
Possible effect on distributable reserves
However small, a PLC must apply the "option expensing" accounting rules in full. This means that any share incentive scheme (not just an option scheme) that confers benefit on the recipient must be expensed against profits over the period from the award to the time the benefit crystallises. This is despite the fact that share options are a cost to shareholders, not to the company. Since there is no cash cost to the company, the P&L "charge" is reversed in reserves, but the existence of the charge can have the effect of reducing distributable reserves.
Limitation to sales on deferred terms
An increasing number of companies are offering individuals the opportunity to purchase shares, but on deferred terms. This gives the subscribers the benefits of holding real shares immediately – for example the opportunity to receive dividends – but without having to pay for the shares until a later time when cash may be available. This works well if the recipients are employees or former employees. Sometimes, however, a company will wish to offer incentives to non-employed directors, or contractors. These subscribers must pay the whole of any share premium at the time of issue, which defeats the deferred element of the scheme.
Prohibited financial assistance
Many quoted companies like to acquire shares on the open market, for example to be held in trust for use as incentives. However PLCs may not provide the finance for such purchases (so called "financial assistance") unless they do so for the purposes of an employee share scheme, or to facilitate making a market in the shares among employees. Even then, PLCs cannot finance own-share purchases unless the cash can be found from distributable reserves. Many smaller PLCs are fast growing and cash poor, with few or no distributable reserves. To make matters worse, reserves may already have been impaired by the "options expensing" rules mentioned above.
Companies employing 250 persons or more, including any subsidiaries, cannot offer options under the popular, government sponsored Enterprise Management Incentive (EMI). This is a potential problem for companies of all kinds, but tends to affect PLCs to a greater extent because larger companies tend to convert from limited to PLC status. Companies with gross assets of more than £30 million are also disqualified, as are awards over shares exceeding £3m in value at the date of grant.
Share scheme guidelines
several sets of guidelines are published in the UK which purport to recommend limits to the extent of equity based incentives, and the terms on which these are offered. The most detailed are published by the Association of British Insurers. Strictly they apply only to companies which are listed on the London Stock Exchange, but many directors of AIM quoted companies feel that the guidelines should be followed for the sake of good corporate governance. The key ABI guidelines are restrictive: for example, companies are expected to use not more than 10% of their share capital for share incentives, of which not more than 5% should be for discretionary options; unless the total value of shares over which awards are made is less than £1m, in which case the full 10 per cent. can be used.
Overall, therefore, companies face significantly tougher regulation as they move from private to public limited status. Total or partial solutions exist for most of the problems identified in this article, although there are a significant number of companies where the scope for manoeuvre is limited. These are the companies that find themselves within a share incentive "dead zone", which places them at a significant competitive disadvantage. We hope this situation will be corrected by legislation at the earliest opportunity.
Meanwhile, if you would like to discuss any of the above points in relation to your own company, please contact us on 020 8949 5522 and ask to speak to one of our advisers.