Reaping the rewards – reduce investment risk by incentivising key people 14/02/2011

There are many factors that contribute to a strong business case or investment proposal – a quality product, proven track record and strong brand image, for example.   Of equal importance to investors however, are the people within the organisation who will drive the business forward, using their skills and experience to safeguard an investment and deliver financial growth.

Retaining these key employees offers a company many benefits such as continuity, improved morale and reduced training and recruitment costs. The reverse is equally true; the failure to retain key employees can have damaging consequences that all businesses should consider.

The challenge to a business is how to keep key members of management and employees where they are, Salary increases, bonus payments and non-financial benefits such as flexible working hours are potential incentives but do not  deal with the longer term risk.   One solution may be to allow the key people to really become part of the organisation by giving them access to shares or share options which results in the employee remaining with the business and helping it to succeed.

It is important to understand the terminology which applies to share options. An employee is granted an option over shares i.e. the employee is given a legal right to acquire a set number of shares in the company at a future date and at a price which is fixed when the option is granted. Ownership, both legal and beneficial, does not pass to the employee until they take up or exercise the options. It is at the time of exercise that the employee must make a payment to acquire the rights to the option shares.

From the employee’s perspective, until the share options are exercised, they can choose whether or not to purchase the shares without any cost or penalty and therefore without any risk. This is a key difference between share options and shares which must be purchased at the outset. An additional benefit of certain share option schemes is the ability to grant share options which are tax efficient, allowing the option holder to benefit through a lower rate of tax than that which would apply if a bonus or salary increase were to be paid instead.

From the company’s point of view, the share options can be linked to achievement of any number of specific and measurable goals, such as a certain level of profitability within a specified period of time. This way, the employee has a clear incentive to remain with the business and to help achieve a financial goal.  At the time the employee exercises their shares, the company may also be able to claim a corporation tax deduction for the difference between the exercise price (set at the time the options were granted) and the value of the shares at the time of exercise.

So the potential benefits to all stakeholders of a company are clear whether it is in relation to seeking investment, considering a disposal or some other form of corporate transaction or whether it is to simply protect the company from loss of its most important asset which could, potentially, leave at any time.

At a time where finding and retaining the right people can be a major challenge, implementing a share option scheme can be a highly effective and cost efficient means of maintaining or improving the prospects of any business and therefore reducing the risk of failure to maximise investment returns.

If you would like to discuss the opportunities offered by share option schemes please contact your engagement partner, our Corporate Finance team or David Dowell from our Corporate Tax Team.

A version of this article appeared in the Mergers and Acquisitions 2011 supplement to the Press and Journal.