Employee Incentive Plans (UK)

What are employee incentive plans?

Employee incentive plans have evolved to take many forms. In western countries, employers commonly award shares in the employing company as a means of incentivising employees to grow the value of the business while saving cash costs. But this may not be appropriate for every employer, particularly in countries where local customs, laws and business practice have led to preferences for other types of plan. These include “phantom” share plans, cash bonus plans, savings plans and pension plans, “flexible benefit” plans, etc.

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Key benefits of employee share plan

Giving employees a stake in the business can provide a range of benefits to a company and its owners:

• It can help attract key employees who may expect such benefits particularly if they have enjoyed them in other companies.
• It can motivate employees to help grow the business and therefore the value of their stake in it.
• It can encourage loyalty by causing those who resign during any chosen “vesting” period to lose their accumulated share rights.
• By encouraging employees’ contribution to growth and giving them potential for realising value when they sell the shares, it eases pressure on immediate cash costs in salaries, bonuses, etc.
• These benefits are made even more attractive by lower tax rates charged on capital gains compared with cash earnings.
• Particularly in private companies, share plans can give business owners a means of realising part or all of their investment in the business without selling to outside investors, and of doing so at favourable tax rates.

What you need to consider when designing your employee plan

In choosing the type(s) of plan to be offered a range of design choices should be considered to ensure that it meets the needs of the particular business, its owners and employees:

• What proportion of the share capital of the company is to be allocated to the plan and should its value be allocated among the participants?
• How will the shares be funded – will they be existing shares purchased from (or gifted by) current shareholders or will they be newly issued?
• Should shares be given to employees at the outset or should options be granted to acquire them later?
• How will employees realise the value of their shares in due course? In a quoted company the shares can normally be sold in the market but in a private company, will the sale be dependent on the company itself being sold or floated, or will the controlling shareholders buy the shares, or should the company establish and fund an “internal” market such as an employee benefit trust to act as a market and warehouse for shares?
• Should awards be made only to one or more members of the senior management (this more likely in smaller companies) or would an “all employee” plan be suitable (more likely in larger companies once the senior management have been catered for)?
• Should employees’ share awards include rights only to sale proceeds in due course, or also to voting rights and/or dividend rights, or some combination of these?  
• Should vesting conditions be attached so as to encourage loyalty by causing those who leave to join competitors, etc during a vesting period (say for three to five years) to lose the value of their accumulated share rights on leaving? Should “good” leavers (who leave on retirement, or by reason of redundancy, ill health, etc) be entitled to enjoy some or all of the value accumulated in their shares?
• Should a special class of share be created for use in the plan, for example “growth shares” whose rights to participate in any capital value is limited to any such value created above a current “hurdle” level corresponding to the current value of the company? This may ensure that the shares have minimal value at the time of award but may acquire disproportionately higher value if the value of the company grows.
• How should the benefits of the plan be communicated to the target population, so as to ensure that the value on offer is fully appreciated?

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Types of employee share plans

Commercial practice and the tax system have developed a wide range of types of employee share planss, each created to meet particular needs depending on the size of the company, the nature of its business and the population of employees to be invited to participate including:

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Enterprise Management Incentive (EMI) Share Option Plans

A tax advantaged plan intended mainly for selected employees in smaller trading companies (with up to 250 employees and gross assets of up to £30m). Find out more >

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Company Share Option Plans (CSOPs)

A tax advantaged plan mainly for selected employees in larger companies and in others who do not qualify for Enterprise Management Incentive plans. Find out more >

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Share Incentive Plans (SIPs)

This is a tax advantaged 'all employee' plan under which shares can be awarded annually to all staff or only to those who are prepared to invest some of their earnings in the plan. Find out more >

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'Save-As-You-Earn' (SAYE) Share Option Plans

A tax advantaged plan allowing employees to save from their earnings and apply the savings in exercising share options over a 3, 5 or 7 year period. Find out more >

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Long Term Incentive Plans (LTIPs), Performance Share Plans, Restricted Share Plans and others

A range of “unapproved” plans which arise in practice to meet commercial needs.

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Employee Ownership Trusts (EOTs)

This is another tax advantaged arrangement which allows the existing owners of the company to sell a controlling shareholding to a specially designed trust free of tax. The trust must meet certain requirements designed to ensure that the company is owned and controlled for the benefit of the employees as a whole. Find out more >