Tuesday 14 July 2020 10:05 amEY Talk

Finding the best way to incentivise management

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EY UK&I Absolute Partner

With cash at a premium, businesses could be considering an award of shares to employees instead of bonuses. This could be a good way to incentivise key employees in the long term without utilising cash and perhaps a first step towards unlocking liquidity for owners through, for example, a management buy-out. However, with share values volatile, is the right information available to business to get the most out of any new arrangements?

Businesses are facing many people challenges, including how and when to onboard furloughed staff as well as how to engage the workforce in the transition to a ‘new normal’, especially in exploring the efficiencies of remote working with the potential impact of a physical return to work on real estate needs. Above all, businesses will be looking at how to attract and retain people with the right skills for what comes next.

New reward arrangements

Setting salaries at the right level is important but, given the particular pressures on cashflow, many companies may be looking to take a broader approach to remuneration and reward packages involving equity incentives, performance bonuses and commission arrangements. Each business will have its own requirements and each management team will have its own priorities. Getting the remuneration packages right for teams and key members of staff will help to ensure maximum buy-in for your business strategy and alignment of interests in the longer term between management, shareholders and other investors.

The psychological impact of the pandemic, both in personal and business terms, has accelerated how owner-managers are thinking about the future, particularly in situations where a significant proportion of personal wealth is tied up within a business. In the coming years, incentivising management teams to invest into the business in which they work, alongside, perhaps, well-funded growth capital investors, could be an effective way of re-balancing an owner-manager’s ‘personal balance sheet’ as well as giving the business balance sheet added resilience and encouraging new energy and ideas.

Implementing a new equity-based arrangement will have a low upfront cash cost compared to cash bonuses. It is not going to be straightforward though for businesses to decide on the level of grant or award and set appropriate performance conditions. The challenge will be in ensuring that the ultimate pay-out reflects performance of the business. This may involve including conditions to adjust unvested amounts to avoid windfall pay-outs while still ensuring that the arrangements are valued by those participating.

The current market volatility may mean that it is appropriate for shares to be issued to employees at a lower value than might otherwise be the case. This would mitigate any upfront cost for the employees but again thought needs to be given as how quickly the value of the shares might change.

Exiting arrangements

At the same time, businesses may face two very different challenges in respect of equity schemes they already have:

  • The situation where employees are expecting incentives to be paid out in the near future, which may no longer be easily affordable. Businesses may need to consider whether there are performance adjustments in the incentive arrangements and how to obtain any required consent from participants and possibly shareholders to any necessary deferral or cancellation of incentives. There will likely be tax and social security issues to consider too.
  • The opposite position, where the incentive terms are unlikely to be met so that there will be no pay-out but, in order to retain and motivate participants, businesses want to allow some form of pay-out even if spread over time.

The importance of data

In both setting the terms for new arrangements and in amending existing arrangements, a key requirement will be to have quality data and evidence available, not just for the company but to support discussions with other stakeholders. In helping to frame the terms of any agreements, finance directors (FDs) will need to provide detailed analysis of past, current and future performance so that transparent agreements can be reached, minimising the potential for later surprises.

Data and analysis will then be required going forward to monitor the performance of the incentives and of course to ensure compliance with any tax or regulatory requirements. For example, we know that HMRC continues to focus on equity incentives, be it in the form of qualification for say entrepreneurs’ relief or, more generally, in understanding the method for settling share incentive payments. Ready access to reliable data can reduce both the risk of unforeseen outturns on the incentives and the risk of unforeseen tax and social security obligations; whether directly for the company or indirectly in reducing the value (and thus the incentive) for the employee.

Having the relevant data to hand and being able to ensure it is used consistently when it is being used for a number of different purposes is a key part of making equity incentives work as part of the strategy for driving the business forward. However, the opportunity is there to add extra value through interpreting the data and using it as an active part of talent recruitment and retention.

To do this, companies need to free up the time of their FDs and CFOs to allow them to make the best proactive use of the data available to them.

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