It is important for all companies to retain key members of staff who can add value to the business. Many companies do not consider this issue until it is too late and the employee has arranged a new position elsewhere.
This article provides a “high level” review of the main options that are available to incentivise key members of staff under English Law. The options include the following:
1. Bonus Scheme – In general (with the exception of non-contractual bonuses) bonus schemes are included in the employee’s employment contract and therefore the terms of a bonus scheme tend to be tailored to each specific employee and their position/ job function.
Bonus schemes can be structured in various ways and include: (i) Non-contractual bonuses which are not included in the employment contract and are generally payable at the discretion of the employer; (ii) Contractual bonuses with performance criteria – the bonus is determined by performance criteria of the employee and/ or the business; (iii) Contractual bonuses with contractual terms - includes bonuses determined by personal performance targets, pre-tax profits, Earnings per Share, EBITDA or a bonus pool; (iv) Repayable bonuses/ clawbacks – employers may seek to make bonuses repayable in certain circumstances.
2. Employee Share Options – there are various types of share option schemes with different qualifying criteria. If the intention is to only offer share options to select senior employees then a discretionary share scheme would be appropriate which enables the company to select which employees will be offered the options.
Many Employee Share Option Schemes are either approved by HMRC and/ or there is an obligation to notify the scheme to HMRC. In certain circumstances the share scheme can be a tax efficient way of incentivising staff. In the first instance an employer should take tax advice in relation to the most tax efficient scheme from the employer’s perspective.
Most schemes include option rules adopted by the company and also specific share option agreements between the employer and the employee which are granted subject to the rules. If the employee leaves prior to exercise of the option then the share option should terminate.
The option agreement will include specific triggers for exercise of the option and many option agreements contain options that can be exercised in instalments. Common triggers for exercise of share options include: (i) performance targets of the employee and/ or the business; (ii) time periods after which the options can be exercised; (iii) specific events such as the sale of the business or an IPO.
3. Phantom Share Options - This is a right to receive a cash bonus calculated by reference to a notional share option. The phantom share option holder will not own the shares upon exercise.
The cash bonus paid upon exercise of the option will equal the gain that could have been realised at the time the bonus is paid on the exercise of an option to acquire a certain number of shares at a certain exercise price (usually defined by the market value of the shares at the time the phantom option was granted). Phantom options will usually be subject to performance conditions, continued employment requirements and vesting periods.
4. Shares – Shares can also be offered to the employee. This is a high risk strategy if the employee is offered shares without establishing a working relationship with the management team and things don’t work out. In such situations the shares should be transferred back to the company and/ or the other shareholders upon departure of the employee.
The shares should be subject to the terms of the Articles of Association of the employer and also a shareholders agreement between the various shareholders. The shareholders agreement should include the rights and obligations of the shareholders, and also what will happen to the shares in the event the employee shareholder leaves the employer.
