Incentives are considered the most important means of motivating and retaining management within a company. This often formed a significant portion of the ‘total package’ offered to retain and motivate company executives. But, recent changes in legislation, economies and business models have complicated (and reduced) many of the intrinsic benefits of such strategies, however, there remain sound reasons for using incentive strategies. Understanding and applying the objectives for well designed incentives are critical in the design, development and implementation of such structures.
Goals for well designed incentive strategies
Pitfalls of many current share incentive schemes
Companies reward staff with incentives in order to align their interests with that of the company shareholders to mitigate the impact of the principal-agent problem. However, the following risks are present in many structures.
- Employees often don’t have resources to purchase shares in the company they work for.
- Using ‘after-tax’ remuneration is inefficient from a tax perspective for the company and employee.
- Issuing shares at a discount to fair value is dilutive for existing shareholders, taxable as a fringe benefit.
- Delaying the purchase of shares results in the employee “losing out” on the growth of the share value.
- Certain schemes promote the ‘wrong’ incentive which can harm the company and existing shareholders.
Benefits of share incentives
Successful incentive strategies provide numerous benefits to companies and individuals and have been part of effective organisational strategy for many decades.
The numerous benefits of introducing incentive strategies, include:
- Creates shareholder value
- Improves business performance
- Alignment of shareholder and employee interests
- A mechanism for retaining and rewarding loyal and performing employees
- Creates a broad-based shareholding in the company
- Tax and cash flow efficient
Many share incentive strategies were both tax and cash flow efficient for both the employee and company. Careful consideration of these benefits should be reviewed if your existing share incentive scheme was implemented prior to 2016. The rules and compliance required to implement and manage share incentive schemes can be complex, time consuming and risky for the company and employee concerned.
COMPANY EXECUTIVES AND SHAREHOLDERS SHOULD BE AWARE OF THE FOLLOWING MATTERS WHEN DEVELOPING EQUITY-BASED INCENTIVE STRUCTURES:
- Executive time and competence is often required
- Structures are complex and may bring friction to the employment relationship.
- Understanding and complying with the varied tax consequences
- The cash flow consequences
- An independent professional is necessary
When determining which strategy to implement, consideration should also be given to the changing nature of the company, financial performance and the inevitable changes in workforce which need to be accommodated by such schemes. Finally, any transactions involving the equity of a company, such as a merger or sale, would bring such an incentive plan into play, and may form an important part in the negotiation process. In establishing a share incentive strategy, be careful to understand your objectives of such a structure as this will invariably dictate how, whom and when your structure is implemented.
More advice on share structures
Addison Advisory Inc. is a professional service firm based in Sandton, South Africa. We provide insight, advice and direction to senior executives, shareholders of emerging and established companies and individuals. Our expertise covers corporate finance, share transactions, business development, strategy and governance matters including executive alignment structures and succession plans. The firm is supported by a team of qualified professionals and associates who provide custom designed solutions, with an emphasis on high-impact, value enhancing work that is clearly understood and supported by our clients.
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