• Incentivising for Success: Business Edge Winter 2015
Article:

Incentivising for Success

01 June 2015

Tim Zonneveld , Tax Partner |

New Zealand: a land of robust economic growth, low unemployment levels and no capital gains tax on shares. This mix ensures that attracting, retaining and incentivising top talent around company performance and shareholder returns has become a red-hot topic for any ambitious organisation.

One set of levers that employers are pulling with increasing sophistication in their efforts to attract and hang onto top people is employee incentive schemes. Varying combinations of bonuses, shares and other incentives are being created to align managers with shareholders around company goals, performance and return objectives.

However, there are pitfalls to be avoided in the quest to get it right, so we offer a few tips below in this highly competitive arena:

Plan your incentive scheme

You spend considerable time and effort in planning your business strategy, and incentive scheme planning should be no different. After all, we’re talking about how incentives can drive your human and company performance. And ‘human’ is a crucial word: aligning behaviours with company objectives and value.

Among the questions that need to be answered when structuring the scheme is whether the design balance is right in regards to short and longer-term goals.

As there are a number of different types of schemes - each with different structures, advantages and disadvantages - it is important to choose a structure that suits your needs.

Do it early

The opportunity to align the performance and behaviours of your leaders to company objectives and shareholders is strongest early on.

If you do this later, as your company grows, you might limit the incentive and return opportunity for your key people. It could also cost you more to change an existing scheme, and the tax consequences could be complex.

The week before you undertake an IPO is not the ideal time to ask yourself how you might reward senior staff who have been there a long time and will help the company to grow. Although investors and analysts want to see management aligned well past an IPO date, you don’t want to erode profitability through a hastily-conceived incentive scheme.

Make sure it is ‘by the book’

The Financial Markets Conduct Act 2013 (FMCA) reformed how companies offer shares to the public.

It provides specific exemptions to employee share schemes from the usual disclosure and reporting requirements. However, the exemptions are not absolute, as you are still required to provide certain warning statements and other information.

It is therefore important to ensure your scheme is in compliance with the FMCA.

Box clever for a successful, incentivised future

Whatever you are aiming to achieve, consider the consequences of   the incentive structure, as they can be major. Implementing a scheme without fully comprehending the wider tax, valuation, accounting and regulatory issues can result in an ugly scenario for your  business.

For more information, contact your local BDO Adviser.

What schemes are out there?

Share options schemes

Employees are granted an option to exercise the right to convert options into shares at a particular future time and at a particular exercise price. Options typically confer no voting or dividend rights until the option is exercised.

Long-term incentive schemes

Employees are granted an option to exercise the right to convert options into shares at a particular future time and at a particular exercise price. Options typically confer no voting or dividend rights until the option is exercised.

Share loan schemes

The employee obtains a loan from the company to purchase shares in the company. The loan has certain repayment requirements and the employee may have other restrictions on how the loan and their shares are dealt with under the terms of the share scheme

Phantom share schemes

Employees have the right to the increase in value of the shares after a certain period of time without buying shares. If an employee is given 100 phantom shares at $1,500 per share, and the company increases earnings by its 40% target when a second valuation takes place, the shares would be worth $2,100 per share - resulting in the employee’s phantom shares increasing from $150,000 to $210,000: a gain of $60,000.

Employee Benefit Trusts (EBT)

EBTs are established to benefit employees with equity-based incentive plans that include bonus plans, share options plans, and phantom share options. Companies sell shares into the EBT, which then facilitates share acquisition for employees through individual agreements and creates a market for private company shares. Over time, senior management become beneficiaries of the EBT on individual arrangements. If they increase the value of the company according to agreed markers, they receive a share in the increase in value.

* These examples provide a general overview of some of the types of schemes available. However, there are many variations and derivatives of these, particularly as they are tailored to the particular needs of the company. Each scheme has various advantages and disadvantages which need to be evaluated according to the particular needs and size of your organisation before choosing the most appropriate scheme for you.

10 KEY QUESTIONS:

Our job is to create the right blend that maximises the outcomes for staff and shareholders while minimising associated issues. Our starting point is therefore to ask these questions:

  1. What are you trying to achieve?
  2. How much do you want to share?
  3. Do you want senior management as shareholders, or as incentivised managers?
  4. Are some senior management family members?
  5. Can your senior management afford to pay for the shares?
  6. Is there some form of liquidity event on the 3-5 year horizon – an IPO or trade sale?
  7. What form of incentives structure would drive the right behaviours?
  8. Is the business going to generate dividends or churn out cash (or no cash) for the next five years?
  9. Do you want to remain a shareholder, gain a business partner, or sell the business to senior leaders?
  10. What happens if…?