Rethinking Employee Incentives - Current considerations and strategies
19 August 2020
In the current climate, businesses are taking numerous measures to conserve cash. With regard to employee incentives, some employees, especially senior executives, are under pressure to forego bonuses or salary in order to help their business manage its finances. However, many companies’ boards of directors are keen to ensure that their senior employees are fully incentivised and locked in to the business during these extremely challenging times.
All of the conversations that BDO has been having are around the directors looking to take difficult decisions in the best long-term interests of the company, its creditors and its employees.
The key to implementing an incentive arrangement, which will hopefully compensate employees in the longer term, is to ensure that they are correctly structured.
Actions being taken include:
- Deferring cash bonus payments, profit shares and dividends – this can be a very effective way of retaining profit within the business to act as a capital buffer, and avoid job losses and material pay reductions across the wider workforce.
- Furloughing employees who are unable to work at present
- Offering unpaid leave and/or sabbaticals: this can be on reduced or no pay
- Delivering accrued bonuses in shares
Current use of Shares, Options and Bonuses
We are seeing a variety of strategies, including:
- Employees being invited to take a salary reduction or deferment, and being granted shares or options, in order to help retain valued employees where the business is currently unable to pay the full remuneration in cash. The value of the shares to be received may be higher or lower than the salary being given up, but is usually subject to underlying corporate performance conditions, with any value subject to future commercial growth.
- Companies deferring cash payments, with employees waiving a percentage of their salary but receiving a bonus in a subsequent financial year if revenue and/or profit-based performance targets have been met. Such measures help to meet the key desire of employees to retain their position, but they may not always be practicable for younger employees with family and other financial commitments.
- Using deferred shares or options to defer tax charges and remuneration, including deferring exercise/vesting (and hence tax charges) on taxable share option exercises/share vesting. This may assist employees who are unable to fund an income tax liability at this stage, or are unable to sell shares due to low or no liquidity in the company’s shares. Deferral of an employer’s National Insurance liability will also assist the business.
- Replacing new bonus plans with share incentives.
- Passing on the employers’ NIC liability on option exercises to employees. One method of achieving this is by granting a nil-cost acquisition facility and transferring the employers’ NIC liability on those options to the employees, who may be prepared to accept this compromise rather than forego the award.
- Taking steps to avoid tax leakage where amounts such as sign-on bonuses have to be repaid if the employee leaves before the end of a specified period. Such amounts are often clawed back on a net-of-tax basis, leaving the company with an effective tax and national insurance loss. Structures can be put in place to deliver the same commercial outcome for the employees, but avoid tax leakage should they leave within the forfeiture period, potentially saving the company substantial amounts of tax and NIC.
Considerations regarding existing Share Options
Companies should review:
- The existing terms of options to check if any amendments to the performance conditions are appropriate to deal with changed circumstances. Where options have an exercise price which is higher than the current market value of the shares due to depressed share prices, companies may consider re-pricing, particularly where an option is nearing the end of an exercise period and it is unlikely that the share price will recover in time. That said, existing shareholders are generally averse to re-pricing, on the basis that they have no similar remedy.
- The impact of exercise or lapse clauses on furloughed employees, or those who reduce working hours.
- Participation in share plans that is linked to remuneration (Share Incentive Plans, SAYE schemes, annual bonuses).
- How they deal with leavers (voluntary or enforced) and whether options lapse or can/should be exercised, including good/bad leaver provisions.
- Particular implications for employees with EMI options include:
- Furloughing employees would ordinarily have been a disqualifying event, as employees are required to work 25 hours per week, or 75% of their working time, to qualify. However, the draft Finance Bill 2020 contains a clause introducing an exception for participants of EMI schemes who are not able to meet the necessary working time commitment as a result of the coronavirus pandemic. The exception will take effect retrospectively from 19 March 2020 and end on 5 April 2021. There is also a provision for HM Treasury to extend the exception for a further twelve months if the coronavirus pandemic has not ended by April 2021. This welcome measure, if enacted, will ensure that such employees do not lose EMI scheme tax advantages as a result of being furloughed because of coronavirus, and that they are not forced to exercise their EMI options earlier than planned due to the epidemic.
- HMRC has extended the usual 90-day valuation window for granting options to 120 days, and many companies are reverting to HMRC and agreeing new valuations for options not yet granted.
- The 90-day deadline for submission of EMI notifications remains, but there may now be a reasonable excuse for missing that deadline.
Practical issues to be aware of:
- Communication with staff and existing option holders and shareholders needs careful consideration.
- Practicalities for dealing with option grants or exercises (signatures, notices, etc.).
- Share scheme reporting (both for approved share plans and wider reporting of events related to shares and securities) for which it seems the normal deadlines will continue to apply (6 July 2020).
- Companies may defer new grants, pending greater certainty.
- Reductions in salary can also impact benefits such as pension contributions/redundancy/termination payments and R&D credits.