Many companies choose to make shares available to employees under an incentive plan at or in the run-up to flotation on the stock market. There are a number of different types of plan available, and the best option will vary according to the individual company's commercial requirements.
Designing a pre-flotation share plan
While there are many different potential share options available, companies need to consider some key commercial points in choosing the plan that is best for them. For example:
- The plan should be easy for participants to understand and easy for the company to administer;
- It may be best to make any share option plan open to all employees, so that nobody feels left out;
- It may be appropriate to make awards to senior employees subject to performance conditions, based on the company's future performance;
- Investors may have concerns regarding senior executive compensation and share plans, which will need to be addressed;
- Companies should consider if any overseas employees will be participating.
The company will need to carefully plan how many shares it will award under its share plans before, and in the period following, flotation; and will have to consider the potential benefit to participants while making a range of assumptions as to future share price. The company will also need to consider existing shareholder guidelines whether it will be seeking a full stock market listing, or a listing on the Alternative Investment Market (AIM).
Types of plan
There are a number of different ways to structure share-based incentives for selected participants. These include:
- Company Share Option Plan (CSOP): a tax-advantaged plan which allows companies to grant options over shares with a maximum market value at the date of grant of £30,000 per participant. Generally, if these options are held for at least 3 years before exercise any gains are not normally income taxable or subject to National Insurance contributions (NICs), although any gains would be subject to capital gains tax (CGT) when the shares are eventually sold. As individuals receive an annual CGT exemption, this can mean that some or all of the value of the share option is tax free. Companies sometimes choose to operate CSOP as an all-employee plan. Find out more about CSOPs in our separate Out-Law Guide.
- Enterprise Management Incentive Plan (EMI): a highly flexible and tax efficient plan which allows smaller trading companies (with maximum gross assets of £30 million), to grant options over shares with a maximum market value at the date of grant of £250,000 per participant. A maximum of 249 participants, and overall maximum value of £3 million worth of shares, is applicable. If EMIs are granted at or above the market value of the shares, no income tax or NICs will be payable on exercise of the share option. Find out more about EMIs in our separate Out-Law guide.
- Non-tax-advantaged options: Despite the tax benefits of CSOPs and EMIs, other share plans which do not benefit from any special tax regime are also common. As there are no special legal conditions or individual limits on the size of share awards, these can be very useful and flexible tools for delivering incentives - particularly where companies do not meet the legal conditions for tax-advantaged plans or have a business need to make share awards above the individual limits for those plans. Any share option gains will be subject to income tax and NICs.
- Performance Share Plan: Also known as a long-term incentive plan, this popular type of plan will deliver the full value of a number of shares only if specified conditions relating to the company's future performance are met. A key consideration in establishing such a plan is whether, and how, to set the same performance criteria in relation to executives and other employees. The value of the shares on acquisition will be subject to income tax and NICs.
There are also more complex share structures available which, under current rules, can deliver the increase in value of any shares as a capital payment rather than as income, so that employees will again be subject to the more cost effective CGT regime rather than income tax. One example is a joint ownership arrangement such as the Executive Shared Ownership Plan (ExSOP™) developed by Pinsent Masons, the law firm behind OUT-LAW.com.
There are two main choices available for all-employee share plans, which are both tax-advantaged. These plans give benefits to employees (through income tax savings), and can also save employer costs (through NIC savings). The two plans are:
- Share Incentive Plan (SIP): A plan where employees have an interest in shares from the outset and, if shares are kept for at least 5 years, special exemptions from income tax and NICs. However, shares issued under a SIP must be kept in a special trust set up by the company on the employees' behalf and so can be costly to administer, particularly for smaller companies. Under a SIP, employees may be:
- invited to purchase partnership shares from their pre-tax income, to a maximum annual value of £1,800;
- awarded free shares to match their partnership shares (up to 2 matching shares for each partnership share, so with a maximum annual value of £3,600);
- awarded free shares, to a maximum annual value of £3,600 - this can be a very tax efficient way to give employees a shareholding stake;
- able to reinvest dividends paid on SIP shares in further shares, to a maximum annual value of £1,500.
Find out more about SIPs in our separate OUT-LAW guide
- Sharesave/SAYE: A plan where employees are granted a share option if they save between £5 and £500 a month for a 3 or 5 year savings period. Options are granted over the number of shares that could be purchased at the end of the savings period at the market value (or the market value discounted by up to 20%) at the beginning of the savings period, using the amount due to be saved and any tax-free interest that would accrue. At the end of the savings period, the optionholder is able to decide whether to purchase the shares or use the savings for other purposes. Tax treatment is similar to a CSOP. Find out more in our separate UK SAYE OUT-LAW Guide and Irish SAYE OUT-LAW Guide.