Coronavirus: could share plans be the answer to cash flow?
Harsh climate for cash
In the wake of coronavirus and the start of the phasing out of the furlough scheme, many of your clients may be laying off staff or shutting up shop to survive. A key aim is to preserve cash flow and retain key talent who will be essential to keeping the business running during the downturn and coming out of the pandemic with a competitive advantage.
These two objectives clash with one other, as one way of preserving cash flow is to cut employees’ salaries or take advantage of the government’s furlough scheme. Clients may be concerned that staff who have been troubled by so much alteration will be looking elsewhere as soon as the job market reopens fully. Many business owners may already be acquainted with the idea, but equity-based incentives can be a genuine differentiator whilst preserving much needed cash for the business.
Share schemes
Payment in shares avoids any immediate cash cost to the business and can be an enormously valuable asset for clients and their employees both in monetary as well as mental terms. The mental aspect of sensing you are in a fortunate position by being asked to become a shareholder should not be undervalued. Sharing equity with employees in this way is often called “sweet equity” as the employee’s investment of skill and effort into the company is rewarded with equity.
Pro advice. Smaller clients will be well aware that their equity is an influential recruitment and retention tool. In a slump such as this pandemic, they may be confronting decreasing profits and cash-flow difficulties. As a result, share-based incentives must move from an important part of a company’s reward plan to centre stage for your discussions with them.
Here, we look at five ways that your clients might use share-based motivations to achieve the dual goal of cash-flow preservation and retention of key staff against the backdrop of the current climate.
Reduced share valuations
The current economic conditions could mean inferior values for shares in smaller companies. Share incentives are a good way to incentivise staff to rebuild the value of the business, whether in the form of HMRC-approved options or growth shares, which we looked at in detail in yr.6, iss.4, pg.2 , (see Follow up ).
Similarly, if clients have been considering share options or other forms of share-based rewards for some time, reduced valuations may be an excellent opportunity for you to implement a proposal. Evaluating the impact of a crisis like this on private businesses is difficult in the short term, and valuation comparators, e.g. using the rule of thumb method, may not always be relevant to non-distressed businesses.
Pro advice. Tread carefully, current developments show that HMRC is shrinking its parameters with this approach to share valuations. Ensure your clients seek your advice before issuing any shares to employees or granting share options.
Postponing cash bonuses
Current and new cash bonus schemes can be transformed to share option schemes, to deliver the reward in shares in its place. Internal markets, such as employee trusts, can be set up as a way to cash out shares in the future.
Companies may already be looking at deferral, as many bonus schemes are not set to pay out because profit objectives or company value objectives will be missed because of the pandemic. It’s therefore a perfect time to look at the alternatives with your clients.
Pro advice. Prolonging performance stages and retuning objectives to match the new financial conditions will also keep existing bonus schemes important for members whilst maintaining cash flow liquidity. A client wanting to go down this route should consult with an employment lawyer in conjunction with you first.
Rebase underwater options
With share prices falling, the cost of exercising existing share options may now be higher than the value of the shares. Where existing options are “underwater” like this and have no instant worth, there are different ways to rebase options to re-establish the incentive effect. This could be by lowering the exercise price payable to acquire the shares or increasing the number of shares the options grant entitlement to. For most options, the company is free to relax the condition as it likes but, where employees have tax-favoured options, they may need to release the redundant options and be given a new option.
Pro advice. For non-tax favoured and enterprise management incentive (EMI) option plans, it’s worth bearing in mind that employees do not actually have to pay a market value price for shares so can be given an automatic in-built profit.
Review current awards
Where existing rewards are based on hitting revenue or profit objectives, these could be changed to conditions which are better aligned to effectively negotiating the crisis. Instead of rewarding staff for achieving a profit level that was set before the coronavirus crisis, performance objectives could be corrected to instead concentrate on immediate and critical concern such as cash management.
Objectives may become insignificant if staff no longer have any chance of meeting them. The combination of hitting short-term targets but deferring costs by payment in shares can be effective for both your client and their employees.
Pro advice. In some cases, options are being amended so the only vesting condition is continuity of employment, sending a clear signal to employees that they are valued.
Many share options will have a ten-year maximum holding period before they lapse. Indeed, this is a formal requirement for EMI options. With the current slump in trading conditions coinciding with the end of the term, options could be varied or replaced to extend their life and maintain their incentive effect.
Crystallising existing share options
In some instances where share option awards have met performance objectives, they are free to be exercised. Encourage clients to exercise these options. One way of achieving this is via a temporary employer loan.
Pro advice. This avoids employees feeling that the situation has prevented them from being able to acquire their shares and allows the client to claim a corporation tax deduction for the excess of the share value over the option exercise price, which will reduce its corporation tax payments at no cost.
Summary
These are just a few suggestions on how to use share incentives in tough times. Whilst managing cash flow is the primary objective, staff are arguably the most important stakeholder, so you and your clients should think of innovative ways to remunerate staff in the most cash-efficient method possible.
Of course, each business is different and as a result not all of these ideas may be suitable for each company. Where employees acquire shares, clients will need to consider issues such as the compulsory transfer of shares if they terminate employment or in the event of a sale of the company, but these are easily dealt with. Seek the correct advice from a share award specialist if you are unsure of how best to proceed or are unfamiliar with the employment- related securities legislation.
Putting together a plan that works for your client is a small step you can take in making sure they come out of this situation successfully.
Previous article on growth share plans
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