What's at stake?

Handing out company shares or options to staff to keep them happy can be a good solution if you know what you are doing and attach conditions

IF YOU ASK any fast-growing company to identify its biggest challenges, money and manpower top the list. For technology start-ups in particular, it is critical to attract top talent to grow the business effectively. But finding the money to tempt people into a potentially risky venture can be difficult.

Companies with high potential live in hope of nailing a sweet venture capital deal. In the intervening period, however, one of the ways of getting and keeping staff is by giving them a stake in the business. But be warned. It is not a quick fix. What you do now will have implications for your business well into the future. To those contemplating the process, there are two key pieces of advice: have a sound commercial reason for doing it, and keep it simple.

It is possible to offer different types of shares with different rights relating to areas such as voting and dividends, but while there may be a temptation to mix share types, it can create unnecessary complications especially in a small company. In most instances, therefore, it is best to issue standard ordinary shares.

“One way a company can proceed is with forfeitable shares, which may be awarded free at the outset but can be taken back if the person doesn’t meet performance targets or leaves the company for a competitor for example,” says Daryl Hanberry, tax senior manager at Deloitte.

Hanberry and Danny Murray, his audit director colleague, advise all types of organisations, including small and medium-sized enterprises, on equity sharing. Murray says there has been a noticeable increase in the number of companies looking at giving employees shares or options. “It’s always been common in tech companies and now we’re seeing it in the social media space, a particularly hot sector. But whatever the sector, the overriding reason must be to meet an identified business objective,” says Murray.

“There is an abundance of schemes out there,” Hanberry adds. “It really is a case of taking advice on which is the best one for your company and being aware of the commercial, legal and taxation implications of your decision.”

There are no set rules on when to give equity. Start-up companies that need to fill a key position may do it on recruitment, whereas more established companies may use it to to retain. Those contemplating offering equity probably have people in mind who have been chosen because they matter to the business now. But will they matter as much in two or even five years’ time?

Before deciding who receives shares, ask yourself if they have the potential to take a more senior role in the company later, or will you have to recruit someone more experienced to whom you may have to give away even more equity?

Having decided to share, it is essential to put time into drawing up your shareholders’ agreement and to get it vetted by a professional so as to avoid the pitfalls. You will need to be aware of the income and capital gains tax implications for your employees. For example, it is possible to give shares to employees or to give them options that allow them acquire shares at some point in the future. Both approaches have different tax consequences.

Your employee does not become liable for tax until they exercise their share rights or the shares are acquired by them.

At that point, they will pay tax on any benefit arising from their shares at the marginal rate of about 52 per cent, when the universal social charge and other levies are taken into account.

If they subsequently sell their shares, they will be liable for capital gains tax at 25 per cent. The taxable benefit of the share awards are not subject to employer’s PRSI, which is something for cash-strapped employers to bear in mind.

Offering shares is attractive because it doesn’t cost you actual cash and, as they are your shares, you can impose any conditions you like on them. For example, if someone leaves, you have the right to take their shares back providing this has been stated clearly in the shareholder’s agreement or share plan documentation. One of the most likely conditions to be included is linking shares to performance.

Another key question is how much equity to give away. Here, too, there are no hard and fast rules but companies typically set aside between 10 and 15 per cent for employees.

For a key hire, however, it may have to be higher. Before deciding on the percentage keep two things in mind: every piece of equity given away dilutes your shareholding; and if your long-term plan is to attract outside investment, they will want another piece of your equity, regardless of the fact that a chunk of the company’s ownership has already been committed.

Putting a value on your company’s shares can be difficult, especially for start-ups, which may not have any revenues or may be making losses. Essentially what you are estimating is “hope value” – as in what you believe the company is currently worth based on the hope of future profits if all goes well.

The fact that the current value of the company may be low based on a best estimate approach may encourage you to award these shares now to employees in order to tie them into the fortunes of the company. However, it is important to ensure the valuation is as accurate as possible to prevent a future challenge from Revenue when calculating any relevant capital gains tax on ultimate disposal.

Having decided to part with equity the last thing you want is employees trying to sell before you are ready. Ideally, you want the shares held until there is a trigger event such as an initial public offering or trade sale. To ensure this happens, you will need to include a condition that effectively creates a “one in, all in” situation.

For companies that have passed stage one development and whose shares have value, the advice is to put a time restriction on the sale of the shares. This can help to reduce the taxable value. For example, the taxable value and associated liability on shares can be reduced by 60 per cent where they are required to be held for five years and a day.

There are also Revenue-approved share schemes available and Pat Mahon, director, PwC HR Services, says they are worth considering, particularly if a company intends to list or to sell within a 3-5 year period.

“A problem with shares in private companies is the lack of a market for those shares,” he says. “With listing or a sale in prospect employees can often be more attracted to share-based pay as they should have a clearer line of sight to crystallising reward. Shares can also keep employees more focused on the key business goals that will create the platform for a listing or sale.”