The economic uncertainty arising from the Coronavirus (COVID-19) crisis has led to the fall and subsequent volatility of share prices of listed companies. Although less immediately apparent, the value of private company shares is likely to be similarly impacted. This coupled with either cash shortages or at least a desire to conserve cash resources could potentially have major impacts on both listed and private companies.
For many companies, salary costs are one of the largest, if not the largest, cast costs. While the Coronavirus Job Retention Scheme (CJRS) has been a welcome relief for some companies; easing some financial burdens, the gradual scaling down of government support will leave many companies concerned with future planning as the COVID-19 crisis continues to impact some businesses.
The fall in share values can create an issue for companies that have granted options with an exercise price higher than the current share price. However, it can also create opportunities for companies to enhance employee participation through new awards of shares to employees taking advantage of the lower values, and possibly use awards of shares to substitute a portion of cash salary.
Enterprise Management Incentive (EMI) Plans
Many smaller private companies operate an Enterprise Management Incentive (EMI) option plan, where tax advantages are maximised when options are granted with an exercise price not less than market value. The fall in share prices would enable EMI options to be granted with a lower exercise price, increasing the potential tax-advantaged return for employees. For companies with an EMI plan, therefore, it might be worth considering granting further EMI options now (always taking note of the applicable overall and personal limits on EMI grants) even if the company would not otherwise have granted it at this time.
CSOPs, SAYE & SIPs
There will be similar benefits for other tax-advantaged plans – CSOPs, SAYE, SIPs. These plans are more commonly operated by a listed company. While for regulatory reasons it may not be possible to alter the timing of awards, companies may wish to consider enhancing the value of such awards perhaps in substitution for a bonus that might otherwise have been payable in cash. The provisions of the plan rules governing the personal and overall limits on award and the timing of grants should always be checked carefully.
‘Underwater’ Options
Options already granted may now have an exercise price more than the current share price. Such ‘underwater’ options can have a disincentive effect on employees if the perception is that the anticipated reward is unlikely to be delivered. In previous downturns, companies have considered cancelling ‘underwater’ options and replacing them with new options with a lower exercise price. While adjusting options in this way addresses the incentivisation aspects of the situation, there can be a perception among investors that this provides an unfair advantage for option holders – if investors are seeing losses, why should option holders be protected? This sentiment can be more pronounced where the perception is that options are being modified for the benefit predominantly of executives. Rather than a blanket approach, it may be more appropriate for companies to consider adjusting options on a more focussed basis, perhaps excluding executive options from the adjustment.
Growth Share Arrangements
A lower share price will also enable shares to be acquired by employees upfront for less. For growth share arrangements, where much of the current value of a share is stripped out by giving the growth share the right to participation in value only over a predetermined ‘hurdle’ value, a lower underlying share price may mean that the ‘hurdle’ value can also be set at a lower level. This would enhance the value that could potentially be realised when the growth-share is eventually sold.
Long Term Incentive Plans
Companies making awards under Long Term Incentive Plans at a time when the share price is low should take care that a subsequent rebound in the share price does not result in a windfall for executives which may not be looked on favourably by investors. Companies should ensure there is discretion in the plan rules for awards to be scaled down if necessary, to avoid such windfalls arising.
Substituting Equity Awards
Companies wishing or needing to conserve cash may wish to consider substituting equity awards for cash salary. Awards could be in the form of options or LTIP awards, or direct issue of shares. This raises practical issues companies will have to consider (the following is a non-exhaustive list of some of those issues):
- The consent of employees will almost certainly be needed, which is only likely to be given if the employees can afford to take less cash up-front, and variations to employment contracts may be required.
- How will the shares for such awards be satisfied? Market purchase is cash intensive so in practice newly issued shares are likely to be required. If newly issued shares are to be used, is shareholder consent (whether issued directly or to be issued under options or LTIPs), or to disapply pre-emption rights?
- How will the tax and NICs due on shares awarded up-front be paid? Companies that use ‘net settlement’ arrangements may wish to change to ‘sell to cover’.
- If the intention is to make awards under existing share plans, do the rules relating to, for example, the timing of grants and plan limits permit the grant of the awards intended to be made?
- When will value be delivered to employees – for private companies will this be delayed until an exit, or will there be earlier opportunities?
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