Why shares may be even more of an incentive

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By Liz Ritchie

At a time when lots of businesses are laying-off staff or shutting up shop, many are working harder than ever to take up the slack to ensure the businesses they work for survive this global pandemic.

With staff potentially on furlough and those remaining in work adapting to meet the changing landscape, many teams are working harder than ever to support their businesses. It’s clear that adaptation can be challenging and stressful.

Against this difficult economic backdrop, many employers are considering what they could offer key people as extra compensation to maintain motivation and retain key staff when the situation eases. Employers are telling us that they’re concerned that staff who have been unsettled by so much change will be looking elsewhere as soon as the job market reopens.

Many business owners may already be familiar with the concept, but equity-based incentives can be a real differentiator in the job market. They are especially worth thinking about in times of economic challenge when asset values are low, cash flow is strained, and the need to incentivise people is most acute. Payment in shares avoids any cash cost to the business but can be an extremely valuable asset for employees both in financial as well as psychological terms.

The psychological aspect of feeling you are in a privileged position by being invited to become a shareholder should not be underestimated. So, with that in mind, here are five ideas on how you might use equity-based incentives to reward and retain key staff.

Deferring cash bonuses

Existing and new cash bonus schemes can be converted to share option schemes, to deliver the reward in shares instead. Arrangements such as employee trusts can be a way to cash out shares in the future but there are alternatives to provide liquidity.

Companies may already be looking at deferral as many bonus schemes are not set to pay out because profit targets or company value targets are now going to be missed because of the pandemic.  Extending performance periods and resetting targets to match the new economic situation will also keep existing bonus schemes meaningful for participants.

Rebasing “underwater” options

With share prices falling, the cost of existing share options may now be higher than the value of the shares involved. Where existing options are underwater and have no immediate value, there are different ways to rebase options to restore the incentive effect.

This could be by lowering the exercise price payable to acquire the shares or increasing the number of shares.  For most options, the company is free to relax the condition as it likes but, where employees have tax favoured options, they may need to release the redundant options and be given a new option.  For non-tax favoured and EMI option plans, it is worth bearing in mind that employees do not actually have to pay a market value price for shares so can be given an automatic in-built profit.

Re-aligning profit-based performance conditions

Where existing awards are based on hitting sales or profit targets, these could be changed to conditions which are better aligned to successfully negotiating the crisis. Instead of rewarding staff for achieving a profit level that was set before the Coronavirus crisis, performance targets could be adjusted to instead focus on things which are of an immediate and critical concern such as cash management.

Historic performance targets may become meaningless anyway if staff no longer have any chance of meeting them.  The combination of hitting short term targets but deferring costs by payment in shares can be effective for the employer and employee. In some cases, we are seeing options being amended so the only vesting condition is continuity of employment. Knowing that staying on through the pandemic will deliver shares at the end of it can be a powerful motivator and align both employee and employer in aiming for long term success.

Extending the life of share options

Many share options will have a 10-year term. If the end of the term coincides with a temporary downturn in trading conditions, like we are seeing currently, options could be varied or replaced to extend their life and maintain their incentive effect.

Crystallising existing share options

Where share option awards have met their performance conditions, so are already free to be exercised, staff could be encouraged to exercise these options. One way of achieving this is via a temporary employer loan.

This avoids employees feeling that the situation has prevented them from being able to acquire their shares but also allows the employer to claim a corporation tax deduction for the option gain, which will reduce its corporation tax payments at no cost.

These are just a few ideas on how to use share incentives in tough times. Staff are arguably your most important stakeholder, so as an employer it is important not to forget that and asses the most appropriate ways to make sure staff feel they are being valued.

Of course, each business is different and as a result not all of these ideas may be suitable for each company. Where employees acquire shares, you will need to consider issues such as the compulsory transfer of shares if they terminate employment or in the event of a sale of the company, but these are easily dealt with.

Seeking the correct advice if you are unsure and putting together a strategy that works for your business is a small step you can take in making sure you and your employees come out of this situation successfully.

Liz Ritchie is head of private clients at Mazars