Capital Quarter Spring 2020: Incentivising staff when cash is constrained

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For many companies, the various measures that the government has introduced to help mitigate the impact of COVID-19 will not be enough.

While furlough may be a valid option for reducing payroll costs for those employees who simply have insufficient work, many businesses will still need to retain at least a skeleton staff and those key employees who really make a difference. And even if furlough is a possibility, the government grant of up to £2,500 per month (generous though it is) may not make a significant contribution to the total gross salary of higher paid employees – which could test their loyalty when the job market reverts to something resembling ‘normal’.

So, is it possible to square the circle of reducing cash outflows, keeping your employees happy, and rewarding their contribution and loyalty at a difficult time?

A potential solution may be to replace some cash-based remuneration with share awards in the company.

The uncertainty and economic impact of COVID-19 will impute a significant impact on asset values – as can be seen from the performance of all the major stock market indices in recent weeks – and there is little question that this flows through to privately owned companies too (in fact, the discount may be even more significant for these businesses due to a lack of liquidity in their shares). However, when the current crisis clears and uncertainty ceases to have such an impact, it would be hoped that these values will bounce back.

If share-based remuneration is a viable option for your business, you will need to consider carefully how shares are awarded to staff. Your shares will certainly still have some value, so free awards of shares will mean that the employee is taxed on that value in the current tax year – which is not ideal from an ‘incentive’ perspective, particularly if the individual is concerned that the value could fall further. Issuing share options, by contrast, does not give an immediate tax charge, provides the employee with an effective interest that they can crystallise in the future and, if structured correctly, can be tax efficient for the employee on redemption.

This is where the Enterprise Management Incentive scheme (EMI) comes in. EMI is an option scheme, so tax liabilities are only crystallised when the share option is exercised. However, the scheme is HMRC approved and, as such, the basis of charge is the value of the shares on the date the option was granted – locking in that potentially lower value today, and incentivising your employees to stick with the company through the hard times so that they can benefit from future growth when things return to normal.
It is worth noting that any share award structure will only generate cashflow benefits to the extent that it affects remuneration that is yet to be paid.
Past salary cannot be ‘reversed’ to generate a PAYE repayment. And of course, if you are changing salaries or bonus entitlements for individuals, you will need to do so in a manner that is compliant with employment law, which is unchanged by the crisis.

Clearly, any share-based reward mechanism in a listed group has wider considerations, with clear justifications needed to support any such award commercially and to not be to the detriment of investors. The directors will need the power to issue such shares (which may be limited to a narrow range of participants), and generally having more than 10% of shares held by directors and other employees is unusual – but it would seem unlikely that modest current awards here could breach such thresholds. Some form of lock in period, to support the incentivisation element, would seem appropriate and would need to be defined.

PKF Littlejohn has significant experience in advising companies, from start-ups to mature established groups, in providing share incentives to their key staff.