FINANCE
New employee share incentive awards : getting the valuation ducks in a row
WE HAVE RECENTLY SEEN A COUPLE OF CASES WHERE A COMPANY HAS ROLLED OUT AN EMPLOYEE SHARE SCHEME AND ONLY DISCOVERED WHEN THEY WERE PREPARING THEIR ACCOUNTS THAT THE SCHEME TRIGGERED SIGNIFICANT PROFIT OR LOSS CHARGES . IN ORDER TO AVOID THIS , IT ’ S IMPORTANT THAT BUSINESSES UNDERSTAND THE REQUIRED VALUATION STEPS BEFORE IMPLEMENTING ANY SHARE INCENTIVE SCHEMES .
by MATTHEW RAYNER , DIRECTOR AT AZETS , Matthew . rayner @ azets . co . uk
What is a share incentive scheme ? Share incentive schemes are a very popular tool to recruit and retain key employees . In some situations , shares can deliver very significant value to employees at the same time as keeping costs down for the employer company and for shareholders .
Share incentives can be delivered in many forms including :
• Tax advantaged share options – Enterprise Management Incentives ( EMI ) and Company Share Option Plan ( CSOP ).
• Performance shares – Stock is given to managers or executives if specific companywide performance targets are met ( e . g . capital growth shares or hurdle shares ).
• ‘ Sweet ’ and ‘ sweat ’ equity – Sweet equity shares are usually given to senior employees during a private equity buyout at a lower price than other investors , whereas sweat equity incentivises employees with profit that they could potentially earn from the sale of a startup .
• Restricted stock – The company promises to pay their employees an amount of stock based on timing or performance restrictions .
• Phantom shares – Employees benefit from the company ’ s share price without holding shares ; when phantom shares are redeemed , the employee will receive cash compensation .
In all cases , there are two distinct valuation aspects for any share scheme : the tax valuation and the share-based payment financial reporting valuation .
Share-based payment charges – why can they be so high ? Many share schemes are set up with the share-based payment financial reporting aspect being looked at much later in the day . This usually happens when the company is preparing its accounts and realises it needs to book a profit and loss ( P & L ) charge for a share-based payment .
While some generalist accountants will often be happy to prepare a tax valuation , the share-based payment financial reporting calculation usually requires an option pricing model so typically should fall to a specialist valuation team instead . When businesses don ’ t engage valuation experts from the outset , it can often come as a surprise that the share-based payment valuation ends up so much higher than the tax valuation – which is possibly too low .
One of the downsides of a low tax valuation is that employees end up being hit with an unexpected income tax charge when they get their shares . The bigger commercial issue might be that reported earnings may be much lower than expected . In practice , someone reading the accounts may not take the time to investigate the share-based payment charge which is rarely identified separately on the face of the P & L .
There are examples of companies , particularly around the time of an initial public offering ( IPO ), where the tax value and share-based payment valuation are millions of pounds apart . HMRC ’ s Shares & Assets Valuation team has disclosed that there has been an exercise to identify cases where these discrepancies arise , so there is increasing scrutiny facing businesses adopting share incentive schemes .
Financial reporting differences Any company reporting under FRS 102 ( excluding FRS 105 for micro-companies ) or IFRS will need to obtain a financial reporting valuation . A common misconception is that a tax valuation can be used for financial reporting purposes when calculating sharebased payment expenses for inclusion in the accounts . Very often , people think that the employee has paid the tax value for their shares so there cannot be any share-based payment charge . Unfortunately , this is not the case . Financial reporting valuations must be prepared under formal accounting standards and the valuation principles are not the same as they are for tax .
We are here to help If you are looking to implement a share incentive scheme within your business and require any guidance , please get in touch .
Local Offices : Ashford : 01233 629 255 Canterbury : 01227 454 861 Maidstone : 01622 690 666 Orpington : 01689 827 505 Sandwich : 01304 249 997
www . azets . co . uk
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