Key considerations for employee share schemes

Employee share schemes can be a great way to attract, retain and incentivise staff. They haven’t been widely used in New Zealand, with a big part of the problem being that the rules you need to comply with to offer one make doing so impractical and, in a lot of cases, also undesirable. On 1 April those rules got completely overhauled.

To offer an employee share scheme under the new securities law exemption that went live from 1 April, certain basic eligibility criteria must be met. Before an employee participates in the scheme the company must give them a document that describes the plan and its terms and conditions and contains a prescribed warning statement. They must also be given a copy of the latest annual report and financial statements (or a statement to the effect that they can be obtained from the company).

First things first though. The fundamental question you’ve got to ask yourself is why you’re looking at offering an employee share scheme in the first place? Does it make sense for your company? How will the scheme complement the company strategy? How will it impact on governance and management? What are you hoping to get out of it? That will dictate the entire structure of the scheme and guide you through the key issues, including the following.

You need to think about the type of plan you’re going to offer, and who it will be available to. Only a few key employees, or everyone? Generally, under an employee share scheme either shares or options to purchase shares are issued. However, there are various possible structures, each with its own legal, accounting and tax implications.

How much of the company will be allocated to the scheme? Unless the scheme is intended to create a one-off benefit, you should do a budget to cover any existing staff, new staff, promotions, performance bonuses and to promote long-term retention.

Another key issue is the vesting rules, that is, the milestones that need to be reached before an employee can benefit under the scheme. Typically 25% of an entitlement will vest one year after being granted, with the remainder vesting in equal monthly portions over the following three years. What should happen to an employee’s vested and unvested entitlements if they resign or are terminated, or get sick or die?

If you’re reading this as an employee there’s plenty to think about for you too. It’s essential that you understand the benefits and risks of the scheme before committing to it, especially if your participation is going to be in lieu of part of a cash salary, which is often the case.

Know the type of scheme and its tax implications for you. Know how much you’re getting, what the existing capital structure of the company is, and how and when your interest will be diluted over time. Does the vesting schedule match how long you expect to be with the company? Are there any circumstances under which you can lose your entitlement? Do any of the company’s existing investors have a liquidation preference (which can significantly impact on the returns that everyone else will get)? You might not be in a position to change much or any of this, but you should at least understand it before getting involved. And it doesn’t end there either. The value of your entitlement changes over time with the fortunes of the company and as additional capital is raised. It’s important to try and stay on top of what’s happening in order to be able to assess the value of your entitlement at any time.

This article was first published in the Your Law column in the Sunday Star Times on 30 March 2014.

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