[Question] Employee Share Options

[davidbann]

Hi,

I have a PTY LTD company of which I hold 100% shares. I am looking at various incentives for employees, one of which is share options. I would like to get suggestions on how this works best.

I have heard of companies that, at the end of the year, offer a bonus OR share options in the company. So essentially, the employee can choose to take the shares or the bonus. This means that those who take shares have a deeper emotional link to the company since they in effect sacrificed a bonus for the shares. Any suggestions on the best way to approach this?

Some questions:

1. What percentage of the company shares should be reserved for employee share options?
2. What legalities are there around share options? In other words, things like share certificates, audit requirements, legal agreements etc...
3. Once employees have shares, what can they do with them? Can they sell them to public? Should we offer a buy back scheme?
4. Are there any tax benefits to employees who take share options?
5. Are there any tax benefits to the company offering share options?

Any advice or suggestions would be appreciated

Regards,
David

[CLIVE-TRIANGLE]

Hi David

Firstly such schemes can be hugely complicated. I personally see little scope if the company is not listed.
First off, I assume that your company was incorporated under the old Act. You should first harmonize it with the new Act by adopting a custom Memorandum of Incorporation. In this process, you would need to consider:
(a) Increasing the authorised ordinary share capital (usually 1000) to a far bigger number.
(b) On conversion, your issued shares would rank equal in rights and value (pari passu) with the new shares. Normally you would have 100 issued or something similar. For obvious reasons you would need to increase that ... under the new act shares have no par value but you could do it at R1 / share for example, or even less because the board decides the price.
(c) If you intend that entitlement is dependent on service, it may be that you should have a second class of share, possibly with restricted rights. Ordinary share shareholders have voting rights. Consider the nature of any shareholder meetings to see where I am going with this .....
(d) Any conditions and terms must be included in the MOI. Shareholder agreements are unenforceable under the new Act.
(e) If drawn up properly, the MOI and the Act restrict the transfer of shares, so no, an employee cannot sell it to simply anyone. Normally he could only sell it to the company or a fellow employee. The MOI must determine that.
(f) I suppose the issue of dividends should be at the top of the list; if the company is not (or anticipated that it won't be) in a position to pay dividends, the exercise is pointless, because if the class of share specifically excludes control, and there is no dividend, there is no point to it all...

Regarding income tax:
(1) If an employee acquires shares in terms of the scheme by means of a bonus or salary sacrifice, or it is tied to service, the current position is that the employee is taxed as if it were remuneration. So no tax benefit. I don't see one for the employee either. Dividends would be taxed as normal.

If none of these issues seem daunting, definitely engage a professional to set it up. It will be expensive.

[davidbann]

Hi Clive,

Thanks very much for the comprehensive response - much appreciated!

A lot of food for thought...

You sound pretty knowledgeable in this - are you an attorney?

[CLIVE-TRIANGLE]

David,
No I work for an honest living

I am a company secretary and accountant.

[Dave A]

I personally see little scope if the company is not listed.

+1

When I investigated this some years ago, the sum of my auditor's advice was "we recommend you stick to your profit sharing scheme."

When you're already a public company or heading towards an IPO in the near future, 99% of the issues involved are already in play. When you're a closely held company and expect to stay that way for the immediately clear future, it's a massive step and paradigm change.