Reward without using up cash

Oct 14 2009 By The Journal

Fast-growing companies need high quality employees, but how can you retain and reward key staff without using up cash? Ward Hadaway tax partner Paul Christian has some tips.

A BUSINESS is only as good as the people who work in it, so fast-growing companies such as those in the Fastest 50 clearly have some high quality employees.

However, with the current economic situation, spending precious cash on attracting and retaining key staff can be difficult, especially when it comes to smaller expanding businesses.

This is where employee share option schemes come in.

In a nutshell, these schemes allow staff the chance to become shareholders in the company they work for.

As well as giving employees a benefit without a company having to pay out cash, employee share option schemes are also tax-efficient as much of the ultimate benefit is taxed as capital gains, currently at 18%.

With the proposed increases in income tax to 50% and increased National Insurance, this enables both staff and company to keep more of what they have worked for.

The tax efficiency also depends on the value of the company so it is easier to argue a low valuation in the middle of a recession than in a boom time.

Putting in place a share option scheme need not affect the overall management of the business since schemes can be structured as exit-only option schemes.

This means that the employee has a right to get shares but only when the company as a whole is sold.

The employee is then only a shareholder for a very brief period of time before the shares are sold.

In effect, the share scheme gives the employee a cash bonus on a sale. Even if employees get shares immediately, non-voting shares could be used.

Compare to a cash bonus, employee share option schemes also reduce your tax bill.

On a cash bonus, income tax (at potentially 50%) and National Insurance (both employees' and employers') will be payable. Under an employee share scheme, in some circumstances, all the proceeds will be subject to CGT at 18%.

There is another important benefit. For some employees, being a shareholder or a potential shareholder is important psychologically in making them feel "part of the company" - even if the benefit they get in the end is very similar to a cash bonus.

For owners who do not want to give away too much of the company, there are ways around this.

Although many employee share schemes are based on the employee getting a percentage of the ordinary shares, that does not have to be the case.

For example, shares can be used which do not have any current value and only get value from an increase in the value of the company. Alternatively, shares can be used which can never be worth more than a specified amount.

Mechanisms can also be built into the share scheme to ensure that if an employee leaves, he cannot keep any shares he has and any options lapse.

This can be useful as a way of keeping an employee tied into the company - if he doesn't stay the course, he gets no benefit.

This is particularly useful at the moment for successful companies who want to use the current recession to pick up good employees but are worried that the employees will leave when the economy starts to pick up.

Implementing an employee share option scheme does not need to cost the earth and the benefits can also far outweigh the initial outlay.

What's more, our experience on setting up such schemes means we can do it on a fixed fee basis - some welcome predictability in an unpredictable time.

:: For more details on employee share option schemes, contact Paul Christian on 0191 204 4281 or email paul.christian@wardhadaway.com