Keeping key employees incentivised is normally seen as crucial to the success and growth of any business.
In a brewing context, those key employees may well be the head brewer/key members of the brewing team, a head of sales, marketing and finance (where applicable) or could equally be identified as all full-time employees involved in the business, subject to meeting minimum qualification criteria.
Whilst there are certainly varied and wide-ranging incentives that can be put in place to help keep employees engaged and motivated and similarly, attract new talent, this article is focused on financial incentivisation and the varying tax considerations for an employer.
Enterprise Management Incentives (EMI) Options
The award of shares to an employee might be hugely incentivising for that person, giving them a shared and vested interest in the growth and success of the brewery, on the basis that they will receive a share of any profit dividends declared and likewise, be able to sell their shares for value at some future point but the problem with granting shares to employees is usually two-fold:
- Unless shares are issued at the outset/very early stages when there is little accrued value in the business, the employee is likely to be receiving a significant benefit in kind, assuming the shares are gifted to them, which will trigger a corresponding income tax charge (and potentially employer and employee national insurance contributions) on the value of those shares – in short, it can be expensive to issue shares to employees; and
- If an employee who has become a shareholder then departs the business, the founders will almost certainly want to recover their shares so a robust shareholders’ agreement and set of articles of association will need putting in place (at a cost to the business) setting out such rights. In practical terms, even with such documents in place, it can be a logistical headache for the founders to have to deal with the recovery of shares, especially when an employee has left on bad terms and might try to resist returning their shares notwithstanding the contractual arrangements in place – in summary, there will be expenses involved and it can lead to potential conflict further down the line.
EMI share schemes avoid both of these issues by allowing businesses to grant employees “options” over shares, effectively a right to purchase certain shares at a pre-determined price upon the satisfaction of defined KPIs, in a highly tax-efficient manner for both employee (avoiding income tax charges) and employer (receiving a Corporation Tax deduction on exercise of the options).
Generally, the relevant documents pertaining to the scheme will provide that the options lapse, therefore ceasing to have any effect, if the employee leaves the business so there are no concerns about having to recover anything from the departing employee.
When putting such a scheme in place, the business should undertake a share valuation, likely with the assistance of accountants, to determine the value of the EMI options proposed to be granted which should then be submitted to HMRC for approval before any options are granted. This will ensure that HMRC do not later question the pricing/value attached to the shares and deem the arrangements subject to income tax when the options are exercised. From a legal perspective, a solicitor should be engaged to draft the option agreements and overarching rules of the scheme to ensure they comply with legislative requirements and are fit for purpose.
Unapproved Share Options
Alternatively, companies can offer “normal” non-EMI share options to their employees, also termed “unapproved” share options, which do not require prior share valuation approval from HMRC but equally, do not benefit from favourable tax treatment. Unapproved share option plans are often put in place where employees, consultants and non-executive directors are personally ineligible for the grant of EMI options or the business itself does not meet EMI qualification criteria.
Despite the flexibility that an unapproved share option plan offers to companies, from a tax perspective income tax (and potentially employer and employee national insurance contributions) will be payable on the difference between the exercise price and the market value of the shares at the time they are exercised. For this reason, provided the business and individual in question are eligible to grant/be granted EMI options, these will normally be the preference.
Monetary Bonuses
Although the grant of share options can certainly incentivise and encourage employees to stay with the business long-term, there is still much to be said for the payment of cash payroll bonuses and a business will benefit from having in place a clear and structured bonus scheme and salary review process.
Cash bonuses obviously fall within an employee’s taxable income, so the employer will need to deduct income tax at source (via PAYE) along with employee NICs and factor in its own NIC liability. However, for some employees, receiving a lump cash bonus payment into their account might well be a more appealing and tangible reward than receiving an option over shares that may never become exercisable, or even might never be worth exercising if the business does not grow.
Conclusion
In practice, the best means of incentivising staff and encouraging loyalty, strong performance and harmony in the workplace will depend upon both the specific business and the attitudes and personalities of the employees in question and whilst this article has focused upon financial incentivisation, this of course should not be seen as a replacement for non-monetary rewards (after-work drinks is surely routine!!), offering favourable employment terms and the provision of opportunities for professional development which will ideally sit alongside financial incentives as key motivators in staff retention and recruitment.
To some extent, it will be a process of trial and error for a business in determining which incentivisation tools work best with certain employees and as a business grows, it might be worth utilising a variety of such schemes to ensure that key employees have clear and identifiable targets and goals relayed to them that they will be properly rewarded for meeting.
If you are considering granting share options and would benefit from advice or would like to discuss this topic generally, please do not hesitate to contact Daniel Finn.
