Employee Share Option and Phantom Share Schemes
Tools to help retain and motivate employees...
So, what is an Employee Share Option Scheme?
An employee share option scheme (“ESOS”) is a scheme where an employer offers its employees or selected employees an option to take up shares in the employer company (either straight away or over time) typically at a predetermined and often discounted price. Often the employer company may provide some form of financial assistance for the purchase of the shares by employees. There is no one size fits all scheme and if you are considering implementing a scheme it should be tailored to meet your specific business requirements.
Why have an Employee Share Option Scheme?
In today’s environment it can be difficult to retain high performing and talented staff members. The loss of a key employee can be extremely expensive and also has the potential to detrimentally affect the growth of the company. One way to motivate and retain key staff members is to establish an employee share option scheme. This provides the employee with “skin in the game” and is a great tool to retain them and motivate them to grow the business. It also provides the employee with another form of remuneration which does not involve the immediate payment of cash. They can also be a great tool for succession planning – by providing a gradual transition to ownership.
Are there any legal requirements?
The short answer is yes. However, the requirements are not as complicated as they used to be. Under the Securities Act 1978 it was very difficult and cumbersome to offer shares to employees. However, the Financial Markets Conduct Act 2013 (“FMCA”) (which replaced the Securities Act 1978) and the Financial Markets Conduct (Employee Share Purchase Schemes) Exemption Notice 2016 have greatly simplified things for employers.
Full disclosure under the FMCA is not required if certain requirements are met, including the provision of a warning statement and access is provided to information about the company. The number of shares issued or transferred under an Employee Share Option Scheme must not exceed 10% of the shares issued in that same class.
There are other legal requirements which will apply, and these include the requirements under the Companies Act 1993 in relation to the issue of shares and the provision of any financial assistance for the purchase of the shares.
If the employer company already has shareholders, these shareholders will (depending on the terms of any shareholder agreement) be required to consent to the issue of the options and waive any pre-emptive rights they may have on any issue of shares.
What should I think about if I am considering an ESOS?
- Who are you offering shares to and why? Is this the best way to retain key employees?
- When will the employee be able to purchase the shares? Will they get the right to purchase parcels of shares over time?
- Will the employee be offered the right to purchase shares immediately or will they be able to exercise an option to purchase shares at a later date?
- What are the terms that will apply? For instance; how many shares will be the subject of the ESOS? What will the exercise price be? Will the employer have an obligation to purchase the employee’s shares if they leave? What rights will the shares have – for instance; will the employees with those shares have the ability to vote at any meeting of shareholders? Does the employee have to stay with the employer for a certain period of time before they can purchase shares in instalments or from dividends allocated?
- Will you provide any financial assistance to assist an employee to purchase shares under the ESOS? Can the employee pay for the shares?
- What happens if the employee leaves? Sometimes a scheme may include what are referred to as “Good Leave and Bad Leaver” provisions. Under Good Leaver provisions if an employee leaves due to death, redundancy or illness or accident or after a certain period of time, the employer may elect to purchase their shares for the full fair value. However, if the employee is a “Bad Leaver” (this is where they are dismissed for performance issues or leave before a certain period of time is up) a discount may be applied to the price the employer is prepared to buy the shares for.
- Tax and accounting advice is essential.
What are the possible downsides of an Employee Share Option Scheme?
- Paper work. This should be prepared by a lawyer to ensure that the requirements of the Financial Markets Conduct Act 2013 (which replaced the Securities Act 1978) and the Financial Markets Conduct (Employee Share Purchase Schemes) Exemption Notice 2016 are met.
- Taxation – expert tax advice should be sought.
- The employer company will have ongoing additional obligations to the employee – these come in the form of provision of information and annual accounts/ reports.
- The shareholder will have the rights under the Companies Act 1993 to request certain information and will also have the minority buy out rights under section 110 of the Act (if the employee has voting rights).
- All shareholders of a company also have limited rights to take personal actions against directors (for breach of duties owed to them as a shareholder) and if a shareholder believes the company has been conducted in a manner that is likely to be oppressive unfairly discriminatory or unfairly prejudicial they can apply to the court for an order under section 174 of the Companies Act 1993.
What documentation will be required?
Typically, the employee will be provided with a letter setting out details of the scheme. There may also be a share option deed and shareholders agreement which will need to be drafted. If a new class of shares is being issued, then changes to the Company’s constitution will be required or terms of issue prepared. It is important that all documentation which is produced complies with the requirements of the Financial Markets Conduct Act 2013 (which replaced the Securities Act 1978) and the Financial Markets Conduct (Employee Share Purchase Schemes) Exemption Notice 2016. It is also vital that the document is drafted in a way which is easy to read and understand. There should be no room for anyone to be confused about what is being offered.
Phantom share schemes
It is also possible to create a scheme which does not involve the issue of shares but effectively can have the same financial result for the employee. They can be very useful in situations where a company does not want its employees to become shareholders in the company. They also avoid some of the complexities and legislative requirements of an ESOS.
So, what is a Phantom Share Scheme?
A Phantom Share Scheme does not involve the issue of any shares in the employer company – they give the employee a contractual right to receive a payment in certain situations. There will typically be an agreement between the employer company and the employee under which the employer has agreed to provide the employer with monetary amount in certain situations. Typically, those situations are the right to receive a specified share of:
- any cash dividends declared by the employer company and payable to the shareholders; and
- any cash surplus payable to the shareholders of the employer company on the happening of a certain event – e.g. sale of all of the shares or assets of the employer company.
The documentation requirements are similar to that of an Employee Share Options Scheme but without the need to comply with the requirements of the Financial Markets Conducts Act 2013 or the Companies Act 1993. This means the establishment and maintenance of a Phantom Share Option Scheme is quicker and simpler.
However, the downside is that the employee only has a contractual right for payment in certain situations not an ownership right in relation the employer company.
Employee Share Option Schemes and Phantom Share Schemes can be a great way to motivate and retain key employees. However careful thought and planning is needed to ensure they are established and implemented correctly and in accordance with legislative requirements.
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