Using a share plan is a great way to motivate employees. Clearly, in order for share incentive schemes to be effective, the participant needs to see a way of realising the value in the shares acquired otherwise the incentive effect can be lost. For private companies, there is no immediate market for the shares to be sold on in the future - so the company needs to create one when setting up the share plan.
While companies can buy back shares from employee shareholders, this is often not the optimal solution from a tax perspective and it can also be complicated from a legal perspective. However, there are other potential solutions.
Link the share plan to a future ‘exit’
The most obvious solution is to link the delivery of share plan or other reward to an exit. If there is a likelihood of an exit event in the foreseeable future (ie a sale or a market listing) then the share incentive scheme could be linked to the company successfully achieving this event.
An exit-based plan has the advantage that further minority shareholders are not introduced prior to an exit. In addition, with an exit-based plan there is no cash cost for the company, as the cost will effectively be created by the shareholders.
Using an employee benefit trust
An employee benefit trust (EBT) is a separate legal entity that can be used to create a market for shares in the company to be bought and sold (without the need for a sale or listing of the company).
EBTs are often operated in conjunction with a share incentive scheme, both by private companies to purchase shares from leavers or to act as a market. In addition to creating a market for share scheme participants, the creation of an EBT could be used to facilitate a partial or full exit for existing minority shareholders. The shares acquired from the EBT could then be used to incentivise new members of the management team.
When the participant wants to sell their shares and realise the value held, the EBT could then buy back the shares with further funding from the company as required. The employer can retain control of the timing: participants could be offered the opportunity to sell their shares back from a specified date or when certain conditions are met. To mitigate any company cost, employees who wish to buy shares can be matched with employees who wish to sell shares.
Options could then be granted over more shares retained by the EBT or such shares could be awarded to eligible employees in the future, recycling the shares in the EBT and preventing further dilution for other shareholders.
It is important to remember that an EBT holds shares and other assets for the benefit of employees and directors of a company. Therefore, any assets held by the EBT will be ‘ring fenced’ for the benefit of employees and cannot be reclaimed by the company
There are important considerations around funding EBTs, along with both corporation tax and inheritance tax issues which must be considered prior to implementation
To discuss the use of an Employee Business Trust or other options for creating a market for private company shares, please contact Andy Goodman or Matthew Emms.