More than 70 people, including a large number of share plan sponsor companies, registered for the Centre’s twice pandemic postponed Fourth British Isles Share Plans Symposium, which was held online over three days in late March.
Each day’s webclave featured a specific theme, successively: All–employee share plans & regulation; Executive equity incentives and finally Employee share ownership opportunities for SMEs.
Necessarily, the event format was extraordinary – all the speakers’ video presentations, together with slides, were pre-recorded and distributed among registered participants in advance by way of a dedicated webpage. Logging in, delegates ‘met’ that day’s speakers, who formed a panel to discuss their topic themes. Each interactive webclave allowed delegates to ask panellists questions and to make comments in real time. Live delegate polls on key employee share ownership issues were a big hit throughout the symposium and hugely enjoyed.
Describing market trends, Centre speakers said that the Share Incentive Plan (SIP) had proved quite popular among newly installed share plans during the pandemic. Among the SMEs, the Enterprise Management Incentive (EMI) unsurprisingly was still the big favourite, though its complex rules were criticised as being “an absolute pain.” In the large company sector, quite a lot were using retention equity bonus schemes, which helped preserve operating capital, rather than cash awards for managers and senior executives. However, an opportunity to spread employee share ownership culture perhaps was being lost as comparatively few companies had introduced Shares for Salary Sacrifice schemes for their employees, as the Daily Mail had done. Perhaps they were just too busy trying to stay alive, said one.
Day One was introduced by Esop Centre founder, Malcolm Hurlston CBE, who thanked Ocorian, the independent Channel Islands based provider of corporate and fiduciary services, for co-sponsoring the event. Malcolm praised the quality of the advance video recordings sent in by the speakers. He addressed the key issue of how to make all-employee share schemes more popular with companies and their employees. He agreed that one of the best things government could do for share schemes would be to reduce the current five year employee participation requirement for full tax relief in the Share Incentive Plan (SIP) to three years. Another rule should be changed to stop companies from “punishing” early scheme leavers. In addition, he praised the flexibility of the Company Share Option Plan (CSOP), of which much more use should be made than at present, he urged.
Stuart Bailey, associate director, business development, at Computershare, gave a presentation of a recent study carried out jointly by Computershare staff in Australia and a team from the University of Melbourne, led by Professor Andrew Pendleton, formerly professor of employee ownership studies at successively, York and Durham universities. The study examined the factors behind an employee’s decision on whether to join their company share scheme or not, in this case a monthly employee share purchase plan, often with company matching shares and not dissimilar to a UK Share Incentive Plan (SIP), but with an annual invitation period, like a SAYE-Sharesave scheme. The Melbourne team interviewed 1,100 employees to find out why they had decided either to participate in the company share scheme, or not. Of these, just over 50 percent had joined the company scheme. A key finding was that the longer the share plan had been established, the more likely employees were to join it. Typically, where a company scheme was less than five years old, the employee take-up was very poor, with only 13 percent on average accepting it. However, where a work scheme was well established (for more than five years) employee acceptances were very much higher – at 72 percent. There was very little difference between take-up levels by gender or by income level, said Mr Bailey. Surprisingly, 40 percent of the refusers said that they might be encouraged to join the scheme, were it to be presented to them differently, which could read as Eso’s untapped potential to expand. The research suggested that habitual employee subscribers to the company share plan could be used as informal recruiters among work colleagues who were doubters or refusers. For companies who were fairly new to employee share ownership, they need to spend a lot of time and effort educating employees about the value of share plans. Another finding was that more than two-thirds of employee participants decided on the first invitation day whether or not they would join the company share scheme. The implication was that if companies spent more time on their pre-offer communications, they would get higher employee participation in their share plans, said Stuart. Bite-size, easily digestible bits of information to help simplify such communications material, were recommended.
The survey showed that employees were on the whole well aware of how to join a company share scheme and least aware of the tax issues involved in such schemes.
The number one concern among share plan refusers was anxiety over the company’s share price and whether it was falling or not. If it was falling, they were less likely to participate in the company plan, the survey suggested. More than three-quarters of employees in their company share plan knew about its share price. Most employees consult no-one else in reaching their decision as to whether or not to participate, but when they do, they usually consult family members and work colleagues, said Mr Bailey. On average, employees took more than four years to join the company’s share plan(s) for the first time, he added. Another key point was proof from the survey that employee share plan participants felt more involved in the company’s performance than those who were not.
In their presentation, EQ’s (formerly Equiniti)md, employee services, Graham Bull and industry director, share plans, Jennifer Rudman discussed how all-employee share plans could remain relevant to – and provide for – today’s workforce. Graham said that SAYE, launched in 1980, had got him hooked on employee share schemes. It was one the best and safest products in the market place because even if the share price fell below the option price close to maturity in three or five years time, participants could simply demand their savings back and not lose money. The other tax-advantaged all-employee plan, the SIP, launched in the year 2000, comprised three potential elements: partnership shares bought by employees via deductions from gross salary; matching shares provided by employers and the additional discretionary award of free shares. Statistical tables showed SIP moving up slightly in popularity, while SAYE usage remained broadly stable and many companies operated both.
Jennifer said that the number of share plan invitations had dropped slightly due to Covid last year, but this year the number of companies putting in new schemes was rising. Graham said it was encouraging that many companies floating on the LSE were awarding free shares to their employees, if not launching share plans, as some did too. The pandemic had shown that the current five-year employee participation demanded by HMRC for full tax relief in a SIP was too long. She said that EQ fully supported the Centre campaign to have that tax qualifying period reduced to three years, as in SAYE savings contracts. The government should change the SAYE rules so that if the option price were underwater near vesting time, the original option price could be reset as a ‘look-back’ feature, a change which the Centre supported, said Jennifer. Brexit hadn’t really had much effect on share plan services except that both YBS and Barclays had withdrawn from providing services to Irish companies who used SAYE schemes.
Both Graham and Jennifer asked why weren’t more companies operating all-employee share schemes. It was great when employees in some companies exerted pressure to install one and, as was the case for the SIP, employers could make savings, alongside the gains made by employee participants. They proposed some remedies: *Perhaps companies should have to explain why they didn’t operate share schemes if expectation was high that they should. *Automatic employee opt-ins to company share plans was a possibility for government to consider, as was additional Corporation Tax relief. *Companies should seriously consider reducing employee plan eligibility to three months after joining the company and six months maximum.
To meet refuseniks’ excuses that they didn’t have enough money to participate, or that the share price was too volatile, companies should offer the full permitted 20 percent discount on the option price and offer free shares to employees more often.
Jane Jevon, partner at employee share scheme adviser Pett Franklin, spoke about the Forgotten share scheme – the Company Share Option Plan (CSOP) –and how to unlock its potential and avoiding its hidden pitfalls. Jane explained that the origins of the CSOP lay in the old Executive Share Option Scheme, which it replaced.
CSOP was a discretionary tax-advantaged share option scheme, where options were issued at market value agreed with HMRC. As there was a £30K limit to individual CSOP option holdings it was much more often used as an all-employee incentive these days than as an executive scheme. Performance targets linked to the options were possible, but had to be clear and objective from the outset. Interestingly, CSOP options had to be exercised between three and ten years of grant in order to keep its tax advantages, which made it more useful at a time when the share prices of many companies had fallen due to the pandemic, because option holders could hang on until the share price revived, she said. CSOP was the go-to plan when companies did not qualify to use EMI, either because they had grown too big or because they were in a non-qualifying activity such as banking or forestry. CSOP didn’t require regular savings, as did SAYE schemes, which had the additional disadvantage that options had to be exercised within six months of vesting.
The main pitfalls, which resulted in CSOPs losing their tax advantaged status were those of failing to report the CSOP installation on the ERS portal within the July time limit and failing to make annual returns, said Jane. She reminded delegates that a decade ago, there had been some in government who had wanted to get rid of CSOP but the Centre had campaigned hard to save it. Big quoted companies liked CSOP because it was so flexible. She predicted that CSOP would still be available to companies for many years to come.
Jeremy Edwards, partner andhead of share schemes at Baker McKenzie, examined the concept of paying employees via company shares, to deal with cash-flow crises during the pandemic. To date, the take up of Shares For Salary reduction schemes in the corporate world had been rather low, for a variety of reasons, including the need to focus on survival, or the fact that companies were awarding reduced bonuses, he said. However, a lot of companies were looking at paying out share awards, as it was important to keep employees involved in the business and cash bonuses were hardly ideal in that respect. In addition, share prices in some companies had remained historically low due to the pandemic and so it made sense from a future perspective to launch share option awards now. Salary sacrifice schemes were sometimes not suitable for the mass of lower-paid employees, as they might fall foul of minimum wage regulations, said Mr Edwards. The advantages of share awards included vesting requirements, retention rules and delaying salary tax points. However, there were securities law implications, most notably sourcing the shares, which needed to be either new issues, treasury shares or shares held in trust in order to save cash. Jeremy criticised the “lack of flexibility” in the use of treasury shares and complex regulation. Tax considerations surrounding Shares For Salary reduction schemes could be problematic, he warned – different types of award had different international consequences for tax withholding, social security payments, recharging and tax deduction rules. As institutional bodies were not yet supporting such salary reduction schemes, the quality and relevance of corporate communications about them would be absolutely critical, he added.
The second day’s webclave on executive equity incentives was chaired by Alderman & Sheriff Professor Michael Mainelli, executive chairman of the Z/Yen Group, which operates the Esop Centre. Michael, who sits on remuneration committees, said that a dilemma on the executive reward front at present was whether boards and rem cos should go back on some cancelled or postponed executive equity rewards during the worst months of the pandemic. “Should we go back and reward these executives now?” he pondered. “After all, they have been through hard times and have worked very long hours to keep their ships afloat.”
Symposium participants gave one of the session’s vox pop proposals the thumbs down over whether they would support the award of more powers to regulators to punish companies whose executive reward resolutions habitually attracted more than 20 percent of voter opposition at agms. Only 29 percent of the webclave participants said they were in favour of giving the regulator more power to punish; 50 percent said ‘No’, while the remaining 21 percent were ‘don’t knows.’ Clearly, they thought it was more up to the shareholders to punish company boards over allegedly ‘excessive’ rewards, than regulators; More predictably, 85 percent of participants said they would support remuneration committees who adjusted executive equity rewards at vesting to prevent individuals receiving windfalls from Covid-related share price movements. This was queried by Liz Pierson, partner, tax & legal at Deloitte, whoasked in practical terms how this could be done: “It would be like trying to put the toothpaste back in the tube,” she said. Liz spoke about hard and soft laws affecting directors’ remuneration. She defined hard law as legislation, listing rules and regulation, whereas soft law comprised the investor institutions, such as the Investment Association (IA), the UK corporate governance code and proxy guidance on shareholder voting. There had been little substantive change on both fronts during the past year, said Liz, though on soft law, companies were being asked how they would respond to the pandemic when setting executive remuneration. The revised corporate governance code set out remuneration principles and provisions for companies to follow: Companies had to report how the principles had been applied, what action had been taken and the outcomes. In addition, companies had to comply with the provisions, or explain what they had not. However, Liz said that for years there had been concerns about the Comply or Explain issue – it had been too much of a box-ticking approach both from companies and proxy agencies. “There is a real reluctance to say that you won’t comply with it and provide an explanation for it. Among my clients there is a concern that proxy agencies won’t look at that in the round and so give them a cross in the box, rather than a tick,” she said. The FRC had recently published guidance to help companies become more transparent and said that companies and shareholders should not favour strict compliance over effective governance and transparency. The FRC review said that some companies claimed they had complied with the code in full, but when it had looked more closely at their annual reports, the FRC had found that they hadn’t, or they had explanations that were incomplete or didn’t wash. So while Comply or Explain had been around for many years, it was a concept with which we still had to grapple, said Liz. The FRC had set out two areas of concern: executive pensions and post-employment shareholding.
Executive pension contribution rates, or payments in lieu, had to be aligned with those available to the workforce and if companies did not comply, they had to explain why and give a timeline for becoming compliant. The IA expected companies to have dealt with existing directors’ pension contributions by the end of 2022, but new director hires should be treated on the same percentage contribution rates as the workforce. Proxy agency IVIS said it would red top remuneration reports after 2022 if there was no credible plan to align executive pension contributions with the workforce and if executive pension contributions continued to exceed 15 percent.
The code had set out post employment shareholding requirements (PESR) and the remuneration committee had to work out a policy to cover both vested and invested shares. She explained how this issue was covered in the modern Long-Term Incentive Plan (LTIP), which was still the most popular, usually comprising a three-year performance period, followed by a two year post vesting holding period (as demanded by the IA) and then by a two year post release retention period. The big question was how to enforce PESR once the director had left the company. Liz said that increasingly EBTs and other trustee vehicles were being set up in bigger companies to handle directors’ post-employment pension shares, as nominee arrangements like this were easy to enforce.
Bradley Richardson, counsel at Linklaters, tackled ‘The changing landscape of investor and corporate governance expectations.’ Since January 2019, under the Corporate Governance Code, large company directors had had to explain in their annual reports how they had been promoting the success of the company, the long-term consequences of their policies, the interests of their employees and how they had fostered relationships with suppliers and customers and explain the impact of their operations in their local communities. The new focus on the interests of employees not only involved asking whether they had been given the relevant info about the company’s activities and whether the company had consulted properly but also, for example, whether the company promoted employee share schemes, said Bradley. Now there were mandatory reporting requirements too for larger private companies (those employing 2,000 or more, or a £200m+ turnover or £2bn+ balance sheet) too.
The pandemic had placed an acute focus on executive reward. Whereas the key phrase in executive reward used to be to align reward packages with shareholder interests, now the emphasis was on alignment with stakeholder interests, which included those of employees and customers. Institutional shareholders and the media wanted to know not just what the bottom line looked like, but how company boards had engaged with their employees, said Bradley. Companies were already undergoing a lot of scrutiny on executive pay and the likes of the Investment Association were sending, in some cases, stark messages to boards on reward packages, for example that bonuses should not be paid in companies which had taken taxpayer pandemic jobs support and loud advice that companies should bring executive pension contributions into line percentage-wise with those given to rank-and-file staff. Added to the mix was the required publication of the ceo v median employee reward ratio in companies having more than 250 UK employees, which was being widely reported by the media. Investor expectations were being cranked up, he said.
Many companies had felt obliged to update their malus/claw-back triggers too in the wake of several notorious corporate failures in recent years. On ESG, the FCA now required premium listed companies to make better disclosures on how climate was affecting their businesses. There were many inputs into corporate governance and they were developing at pace, he added.
John Pymm, md of executive compensation services at Willis Towers Watson, examined the theme of seeking leadership on executive pay at a time of uncertainty, with special focus on fairness, performance alignment and potential for change and bespoke arrangements. Executive pay had developed quite drastically as an issue in recent years. John displayed bar diagrams showing that the median direct reward package of ceos within Europe was €3.4m in the top 350 companies in 2019. Of this, 62 percent comprised variable pay – both short-term and long-term incentives. However, short-term incentives were aligned to performance, usually financial performance, profit, income etc. and the median level for short-term incentives was around 90 percent of base pay, but with stretching targets attached. These days, part of the pay out was deferred over a longer period, perhaps two-three years. In addition, there were the long-term incentives (LTIPs) with his bar diagram showing 126 percent as base salary as the median in 2019 (value at the date of grant) Typically, in a performance plan, it might be 50-60 percent of the full value of the award, so within UK market it might reach somewhere between 250-300 percent if all the performance hurdles, linked to the share price, were met over a three year period, with a two year retention period.
More than 60 percent of these top European companies had guidelines on employee share schemes too and so the level of executive compensation in those companies was partly affected by the degree to which executives engaged with Eso schemes, in the context of shares and share value, he said.
Covid was impacting some companies – falls in share prices, lower financial performance – more than others, like the tech companies, like Tesla, where share prices had gone though the roof. So the discretion exercised by remuneration committees and boards was most important, to make sure that awards were fair, said John. Cineworld had come up with a value creation plan, which was really all about trying to keep the company and its jobs alive. WTW had already seen shortened performance periods, quarterly in some cases, to concentrate companies’ minds, especially those in trouble, maybe focussing on cash flow to ensure survival but he and colleagues generally were not seeing changes to in-flight incentives as boards were sensitive to how any such changes might be viewed.
The other key factor in the current mix was ESG, as witnessed by BP and Shell, who had both dramatically changed their business models to work towards net zero carbon emissions, said John: “I am an ardent ESG person – we must change our organisations, otherwise our future will be much more difficult.”
He forecast new strategies to emerge for executive reward, performance pay and so on, in this accelerated period of change. A lot of discussion was in play regarding the role of ESG factors and risks in determining executive reward and how to strike the right balance between the narrative and the right level of reward. People had to think through what they were doing: If there were a seven year holding period for all executive incentive awards (five years within the plan plus two more in post holding), then companies would ask themselves – Why are we seeking a listing on the LSE?
The third day’s webclave on employee share ownership opportunites for SMEs was ably chaired by Professor Michael Mainelli, executive chairman of the Z/Yen Group. Results from three of the day’s online delegate vox pops were especially interesting: (a) 55 percent of voters said that employee share schemes were not necessarily good for every single company; (b) while 84 percent of voters agreed that there was still scope for the expansion of tax-advantaged share schemes, 16 percent said they had reached their limits in terms of taxpayer support and (c) 83 percent of voters thought there was a strong case for replacing executive cash bonuses with shares.
Colin Kendon, partner at Bird & Bird, explained why the Enterprise Management Incentive (EMI) scheme was booming. Lots of start-up companies needed EMI because their management teams needed incentivising every step of the way and yet most start-ups lacked the cash with which to offer high salaries to lure good staff away from their current jobs, said Colin. Latest HMRC statistics showed that EMI now cost the Treasury more in tax reliefs, with average gains of £83K on cash out, than any other UK tax-advantaged share scheme because it was so popular with 12,000 companies using it. There was no Income Tax, nor NICs to pay either on grant or exercise and only CGT to pay on share sales. In addition, user companies could get a Corporation Tax deduction. Yes, EMI reliefs were generous, but HMRC never published the other key numbers – how EMI produced successful companies which generated far more revenue for HMRC than the tax relief cost, which he described as “trivial.” However, many companies were excluded from participating in EMI, either because they were worth more than £30m (gross asset value), employed more than 250 people, or because they were in disqualifying activities, such as financial services, forestry, property development or leasing. Colin said that he hoped that the government would look again at the leasing activity bar, because many companies were involved in leasing goods, which was an eco-friendly activity.
Although EMI imposed a £250,000 limit on the total value of outstanding options held by any one individual, this could be topped up via the award of additional options over growth shares, he said. Many EMI schemes he had set up for clients were Exit Only schemes, in which no options could be converted to shares and then sold unless there was either a company sale, or a change in control.
David Craddock, founder and director of David Craddock Consultancy Services, agreed that some EMI rules should be changed, particularly the ban on leasing because he knew of a scooter leasing company which was banned from using EMI, yet its business concept was very Eco-friendly – to lease instead of buy.
David talked about how SMEs companies were valued, in order to issue shares. He explained the meaning of market value – what the shares could be expected to realise on the open market and how valuation was affected by whether the shares were restricted or not. So the term ‘market value’ took account of any restrictions in place. The unrestricted market value was typically 10-15 percent higher than actual market value was the hypothetical value of the shares, were their restrictions – (say) on dividends, voting on shares, sale of shares, whatever, to be lifted. He then covered shares issued by unlisted companies, including the requirement that all relevant information (most importantly, the percentage of total issued shares being sold) about the shares had to be available to all prospective share purchasers from a willing vendor. Case law was very important in share valuation because it enabled us to interpret the statute, he said. There was a difference between the contracted value (of a share) and its tax value –its availability to any prospective share purchaser worldwide. The term best price meant the maximum price which the buyer was prepared to pay, rather than what the vendor was asking.
Discounts to share valuation often depended upon what percentage of shares were being sold because if less than 25 percent of the shares were on offer, then in most companies control would not be affected. So this would be a minority holding for which only the audited accounts need be presented. However, if more than 25 percent of the shares were being offered, then the vendor would be expected to produce management accounts as well as the audited accounts. Typically, the offer of a 50 percent holding in a company would attract a price discount of between 20 and 30 percent. David then examined the four main bases for share valuation – earnings, net assets, trading record (which HMRC always looked at) and dividend, but all these would be trumped, for valuation purposes, by a real life offer.
Garry Karch, head of EOT at Doyle Clayton, tolddelegatesthat even though the Employee Ownership Trust had been very successful as the new kid on the block since its introduction in 2014, there was still a lot of work to do in order to bring up the EOT to its full potential. Doyle Clayton knew all about the process of converting to EOT status since his firm had converted itself to EOT status in the autumn of 2019.
In the EOT’s early days, the most common structure was a 100 percent sale of the equity to the workforce by the vendor, but nowadays more vendors wanted to retain a minority stake in the businesses they had built up. The EOT was surely better than seeing the vendor selling to a trade buyer or as private equity investor, said Garry. Instead, the EOT focus was on longer-term ownership and preservation of the company’s independence and its jobs in local communities.
The biggest advantageof an EOT to the vendor was that the sale of a controlling stake to the workforce gave total CGT relief, though the exemption applied to only one tax year, he said. However, if an EOT company was sold off quickly, the CGT relief would have to be repaid to HMRC. Another advantage of the EOT was that the trust could pay staff bonuses of up to £3,600 pa tax free. It was little known that employees in a less-than-100 percent EOT could apply, in certain circumstances, for EMI options, or they could set up a SIP, but in general, the major flaw of the EOT was that it did not provide employees with direct share ownership, rather it was an indirect ownership model. “This should be a key factor in helping to close the wealth gap,” said Garry: “Changing the EOT structure to more readily permit direct employee ownership of some of the shares would be top of my list for potential improvements in the scheme.” His firm recommended that owners sold the full 100 percent to the EOT, not only so that they could get the maximum CGT relief, but because the EOT would then have more flexibility to establish an employee share scheme to provide incentives for staff.
While more banks in the UK were now willing to lend to support EOTs, the pandemic had reduced the willingness of lenders to finance cash-flow credit. He called on institutions, notably the British Business Bank, to provide at least partial loan guarantees in order to improve the financing of EOTs.
Robin Hartley, senior consultant to the RM2 Partnership, who was joined by RM2 director, Sarah Anderson on the panel, analysed the taxation and tenure problems facing Growth Shares -suggesting that share scheme malaise could be cured with synthetic exits (financial engineering). However, first off, Robin attacked the suggestion in the recent OTS review that employee gains from holding Growth Shares should come under the Income tax regime, and not CGT, as is currently the case. He said that the OTS suggestion “struck at the heart of growth shares” and he accused it of using a ‘distorted’ argument that growth share holders were somehow privileged, when that was not the case, as there were many circumstances in which investors bought growth shares. He accused the OTS of using a “misleading” set of case studies to back its argument, but he noted that the OTS had concluded that new legislation would be needed to enact its several proposed CGT changes and that meanwhile growth share gains should continued to be charged to CGT.
In some companies, employees suffered malaise regarding share schemes – they had doubts about whether it would pay out, the complexity of some schemes, their inequality of bargaining power compared to an owner-founder who had to sign it off and possible disappointment over their rewards from past schemes. As gains from growth shares involved only the growth in company value above a certain hurdle, the current longer investment cycle – 5.7 years from seed rounds to exit, and a ten year VC cycle, was of great significance, not least because average employee tenure with the same firm was only 4.5 years and ‘bad leavers’ would end up with nothing. How to overcome these facts and fears? – Answer: to get cash to growth share holders on a shorter time scale than was envisaged via a scheduled exit via pre-exit purchases of some growth shares. Complex planning, including inserting put options into Articles of Association, was necessary in order to avoid considerable tax charges, he indicated.
The Esop Centre thanks Ocorian for co-sponsoring the event.