Understanding the Financial Impact of a Share Incentive Plan

Transcription

1 Understanding the Financial Impact of a Share Incentive Plan

2 And you may ask yourself How much might it cost to provide free or matching shares? How much employer NICs can we really expect to save from offering partnership shares? How can we reassure our shareholders that we are using scarce equity on an appropriate scale? What value of reward might employees eventually receive? How much dilution will shareholders experience?

3 Outline Background SIP planning Practical Example - Runways R Us plc

4 Background What is Share Scheme Modelling? Why is it important? What does it achieve? How is it done?

5 What is Share Scheme Modelling? Illustrating the potential financial effects of a share scheme Potentially important for design Importance with scale and sophistication of scheme

6 Why is it important? Shareholders expect methodology Efficacy of share scheme relies on planning, not what feels right.

7 What does Share Scheme Modelling achieve? Aids design and calibration Assesses: Cost to company Company Savings Dilution (if new shares are used) Employee Reward

8 Modelling process Type of share scheme(s) approved / unapproved... + Profile of Company size, shares, employees + Objectives and Growth Plans of Company growth in company value, growth in number of employees Outputs dilution, per employee gains, costs, savings...

9 INPUTS - VARIABLE SIP PLANNER SIP ASSUMPTIONS Annual value of free shares 800 Monthly value of partnership shares 80 Monthly value of partnership shares to which 80 the matching share ratio is applied Matching share ratio Partnership share take-up rate 45 45% GROWTH IN NUMBER OF UK EMPLOYEES %age annual increase in number of UK employees 12 12% Number of UK employees Year Employees GROWTH IN COMPANY VALUE %age annual increase in company value 20 20% Company value & share price Year Company value Share price 1 45,000, ,000, ,800, ,760, ,312, ,974, ,369, ,243, ,491, ,190,

10 SIP planning Free and matching shares: How many comprise a credible incentive? Can the company afford to finance it? Dilution? Combinations of free, partnership and matching shares?

11 SIP planning Employee reward From the purchase of partnership shares? From the award of free/matching shares? Costs/risks for the company Cost of providing free and matching shares?

12 SIP planning Costs/risks for the company (cont.) Accumulation period: If share price, size of contribution to trustees? Can hedge risk, but if share price, company still exposed to further liability

13 SIP planning Company savings Savings on Employer National Insurance Contributions Erosion of NIC savings through attrition Corporation tax deductions

14 SIP planning Dilution Resulting dilution? ABI headroom guidelines?

15 [COMMENTARY] The Financial Controller of Runways R Us plc visits Pinsent Masons to seek clarification on how his company and employees will be affected by the SIP. On the following two slides the Financial Controller describes his business, the initial thoughts he has about the design of the SIP, and his concerns as to how his company and employees will be affected.

16 Runways R Us plc Construction business Wishes to set up a SIP Most employees 40% taxpayers Award free shares ( 1,500-2,000) Offer partnership shares (assume monthly purchase /month) Expect around 30% of employees to take up partnership shares

17 Runways R Us plc Concerns: How will my annual profits be affected? How will the market capitalisation of Runways R Us be affected? What will be the dilution? Efficacy as incentive and reward?

18 [COMMENTARY] Pinsent Masons absorbs this information, but ask the Financial Controller for more information in order to be able to create a model which would illustrate the effects of the SIP. Pinsent Masons seeks information on the profile and growth projections of Runways R Us. The Financial Controller provides the answers to the questions - these are illustrated on the following slide.

19 Runways R Us plc Need to know Profile of company Market capitalisation No. shares in issue No. of employees 45m 10m year attrition rate Corporation Tax rate 20% 30% Objectives/Growth plans Growth in company value (so by year 5, 78.7m) 15% Employee growth 10%

20 [COMMENTARY] Pinsent Masons now has enough information to create a model which will give an indication of the financial effects that the SIP might have on Runways R Us and its employees. Pinsent Masons and the Financial Controller arrange to meet up in a few days time to discuss the outputs from the model. Time passes quickly, and Pinsent Masons is soon ready to talk through the main outputs from the model, as set out on the following slide.

21 Runways R Us plc Employee gain (40% taxpayer) Comparative gain - no tax benefits Cost of free shares Total CT deduction Net employer NIC savings No. shares required Employee ownership Scenario A: Free shares: 1,500 pa Partnership shares: 50 pm 20,082 14,775 3,080, ,135 34, , % Scenario B: Free shares: 2,000 pa Partnership shares: 100 pm 30,144 21,283 4,107,265 1,232,180 69, , %

22 [COMMENTARY] The Financial Controller informs Pinsent Masons of a recent development which has implications on some of the assumptions originally made in the model. This is set out on the next slide.

23 Runways R Us plc Adjust criteria as a result of successful tender to work on Terminal 5 company growth to 20% employee growth to 12% free shares to 800 pa But match all partnership shares on 1:1 basis take-up rate of partnership shares to 45% Assume employees buy 80 partnership shares per month

24 [COMMENTARY] Pinsent Masons re-calibrates the model to take account of this new development, and runs a third modelling scenario, the results of which are shown on the next slide.

25 Runways R Us plc Scenario C: Free shares: 800 pa Partnership shares: 80 pm Matching share ratio 1:1 Employee gain (40% taxpayer) Comparative gain - no tax benefits Cost of free/matching shares Total CT deduction Net employer NIC savings No. shares required Employee ownership 32,148 24,170 2,698, ,641 84, , %

26 [COMMENTARY] The Financial Controller remains concerned about the cost. Pinsent Masons offers the Financial Controller a final thought - how the SIP might be designed to be self-financing. A fourth modelling scenario is run on this basis, and the resulting employee gain and dilution is set out on the following slide.

27 Runways R Us plc For a self-financing SIP: Strip out free shares But plough back net NIC savings to fund matching shares, 8 for 100 bought Employee reward 11,296 Dilution 1.44%

28 Round Up Methodology Scenario running Alternative strategies Sensible and informed planning