Share-based employee incentive arrangements may play only a minor role in a corporate transaction, but sometimes they can be fundamental to the deal structure and documentation, for example where they impact upon ownership of the target itself.
So what basic questions should you always ask at the kick-off meeting, to get you on the right track from the outset?
Here is a checklist of three main questions, most relevant where the transaction is the acquisition of shares in a private company, with the follow-up issues they may raise, and some further steps it may be necessary to take to deal with those issues. More detailed questions should follow at the due diligence stage, but this checklist should help you to scope out the main issues from the start.
- Does the target group operate any share option plans, or other share incentive arrangements under which employees can acquire shares?
| Follow up questions | Potential issues to watch out for |
| What type of share plans does the target group operate?
Are these tax-advantaged or non tax-advantaged? Examples of tax-advantaged share plans might include an Enterprise Management Incentive (EMI), Company Share Option Plan (CSOP), Save as you Earn (SAYE), or Share Incentive Plan (SIP). If the target group operates a SIP, see Question 2 |
If the target group operates tax-advantaged share plans, this may limit the way in which share awards are dealt with in the transaction. For example, tax-advantaged options must be exercised for the favourable tax treatment to apply, so a proposal to pay cash to cancel those options would not be attractive to the option holders.
Loss of tax advantages is likely to de-motivate employees. It may also trigger additional costs for the target, e.g., employer National Insurance Contributions (NICs) costs (it may be possible to pass these to the employees, but that enhances the de-motivating effect). |
| Are the share awards triggered by the transaction? | It may be that particular steps have to be taken to ensure that options become exercisable, e.g., giving notice to the option holders within a pre-set time scale. |
| Are the share awards triggered before completion or only on completion?
Will all share awards lapse at completion (to the extent that they are not exercised or vested)? |
The purchaser’s 100% ownership of the target at completion could be diluted after completion:
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| Have employees holding share awards entered into powers of attorney under which, for example, a director of the target company can sign the SPA on their behalf? | Employees who have not given powers of attorney will have to sign the SPA individually, which increases the administrative burden.
Alternatively, it may be necessary to operate the drag provisions (if any) in the target company’s articles of association. |
| What is the value of the awards held by each employee? | If particular employees (typically senior employees/directors) receive a windfall on completion, this may raise retention issues. |
| What is the aggregate exercise price of each option? | If the exercise price of an option is significant, the option holder may require assistance in funding the exercise price. |
| Will the exercise of options or vesting of awards at completion give rise to an obligation for the target to operate Pay as you Earn (PAYE) and pay NICs? | Failure to operate PAYE/NICs correctly will result in penalties for the target company, and may mean that there have been historic failures to operate PAYE/NICs. |
| Have all tax advantaged share plans been self-certified to HMRC as complying with the requirements to qualify for tax advantaged treatment? | Failure to self-certify tax advantaged plans means that tax favourable treatment will not be available, leading to a PAYE/NICs obligation. |
| Does the option documentation include an indemnity for the cost of employer’s NICs from the employees? | If not, the cost of employer’s NICs must be factored into the deal price. |
| The exercise or vesting of awards is likely to give rise to a corporate tax deduction. | Where this deduction arises pre-completion, it is an asset of the sellers, for which they may require payment. |
- Do any employees hold shares in the target company or any target group company?
| Follow up questions | Potential issues to watch out for |
| Do employees hold shares via a Share Incentive Plan (“SIP”)? | Shares subject to a SIP are held for employees by a UK resident trust. It will be necessary to engage with the trustee to ensure the trustee is ready to undertake any actions required to complete the transaction (e.g., the trustee may need to take instructions from the SIP participants). |
| Are the shares “restricted shares”? If so, were Section 431 elections made on each occasion employees acquired shares? | If Section 431 elections were not made on each acquisition of shares, and the shares were ‘restricted shares’, it is possible that a portion of the sale consideration payable for the shares will be treated as employment income rather than capital gain. This will give rise to PAYE/NICs obligations. |
| Do any of the sellers potentially qualify for entrepreneurs’ relief, or ‘Enterprise Investment Scheme’ (EIS) treatment? | Entrepreneurs’ relief is available only if the shares have been held for at least one year, and EIS only if the shares have been held for three years, prior to sale. Sellers who have not reached those periods of ownership may wish to delay completion until those periods are reached, particularly if this is a matter of a few days or weeks. |
- Does any target group company operate an employee benefit trust, or any other trust of which employees are beneficiaries?
| Follow up questions | Potential issues to watch out for |
| Does the trust hold shares to satisfy share awards? | The transaction timetable must factor in the transfer of shares from the trust to the employee prior to the sale of shares by the employee.
For tax advantaged awards, it is necessary that the employee acquires beneficial ownership of the shares (even if only for an instant), although legal ownership could remain with the trust, which could expedite the completion mechanics. |
| Does the trust hold more shares than it needs to satisfy share awards? | The excess shares may be distributed to the beneficiaries before completion, or must be acquired from the trustee, which in practice means that the trustee will have to sign the SPA. |
| Was the trust financed by loan from the target? | Repayment of a loan will improve the cash position of the target company. If the excess value in the trust is not sufficient to repay the loan, the balance of the loan will most likely be written off. |
| Will the trust still hold funds after awards have been satisfied and any loans have been repaid? | How will the funds remaining in the trust be used by the trustees? Excess funds might be used, e.g., to pay completion bonuses. |
| Has the trust loaned money to beneficiaries, or provided any benefits to an employee outside the scope of the target’s employee share plans? | This raises potentially complex issues under the disguised remuneration legislation. It is possible that there are significant historic failures to operate PAYE/NICs. |
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