Share incentives before and after Mergers & Acquisitions
17 October 2023
In the context of Mergers & Acquisitions (M&A) founders that prepare well in advance tend to have better outcomes than those who don’t plan in advance.
One area, which is often overlooked, is share incentives for employees whether for management or the broader employee population. Establishing the right plan at an early stage in the development of the company can yield better results for the company and employee.
Offering shares can align the employees to the overall longer-term strategy of the company and retain employees within the business. In some cases, companies intend to offer share options or shares to employees and may have made promises to employees without implementing the required agreements. It is difficult to manage these situations if a transaction arises before the company has delivered on its promises and in some cases tax advantages can be lost resulting in less value being delivered to employees. Introducing a share plan at the earliest stage possible can reduce such difficulties while maximising on the motivational benefits of share incentives.
Another point to note is that share-based remuneration is exempt from employer PRSI (provided the shares are in the employer company or a company that controls that company) which can be a significant cost benefit for cash strapped SMEs. Also, in some cases, a corporation tax deduction can be claimed.
There are a range of plans which can be considered as summarised in the table below. In general, though, the first question is whether employees will be granted a right to receive shares at a later date (i.e., share option arrangements) or whether they will be issued shares immediately (e.g., Restricted Shares, Growth Shares). Assuming share price increases, an upfront acquisition of shares will result in a more favorable tax outcome (unless KEEP options are granted) but the plans can be more complex to administer and implement.
Plan Type |
Comments |
Non-Tax advantaged Share Options |
No tax until exercise provided granted at market value or if less than market value provided the shares are not exercisable more than 7 years post-grant. Income tax, USC, and employee PRSI payable on exercise.
While these plans give rise to income taxes at exercise, they can be attractive where an employer wants to offer shares to all employees as there is no risk for the employee. They are also simple, flexible, and easy to understand. |
KEEP (Options) |
The gain realised on exercise of the share option is exempt from income tax, USC and PRSI. Capital Gains Tax (CGT) will instead arise when the shares are sold.
There are several conditions to be satisfied which can make KEEP challenging, including that options must be granted at market value. However, due to the tax benefits, KEEP is worth considering when deciding on what plan to utilise. |
Restricted Shares |
Restricted shares are subject to income tax, USC and PRSI at the date of award. There is an abatement on the taxable value available under Section 128D which reduces the taxable value by 10% per year of restriction up to a maximum of 60%. There is a claw back of income tax if restrictions lifted or varied before the end of the restricted period. CGT will be payable on any growth in value.
This plan may be suitable where the company is seeking to grant shares to management as this group may be willing to take on the risk of share ownership and/or employers may want management to self-fund a purchase shares in the company to better align their interests to those of the company. |
Growth Shares |
A growth share is a special class of share which typically participates in value above a certain hurdle/value. The growth share is subject to income tax, USC and PRSI on award and must be valued for tax purposes. A growth share will have a lower value than an ordinary share (as it tends to have no intrinsic value on award) but typically will have some value (reflecting the ‘hope’ that the hurdle will be met in the future).
This type of share award can be attractive where the owners wish to share in future growth in the value of the company. CGT will be payable on any growth in value. |
One of the key considerations when implementing a share plan is the valuation of the shares. This is important at the outset to ensure the appropriate taxation of the awards (for growth shares and restricted shares), accuracy of the employer share scheme returns and for accounting purposes. It is also important in the context of a potential sale of the business as evidence of the valuation of employee share awards will typically be requested as part of a due diligence. To the extent that shares have been acquired at less than market value, there can be a historical PAYE liability that needs to be addressed as part of diligence which can frustrate proceedings.
Considerations on an M&A deal
The last five years has seen a significant growth of private equity (PE) as a feature in the Irish investment landscape. This has primarily been fuelled by a number of dedicated domestic PE funds actively investing in Irish businesses coupled with strong inbound investment in particular from the UK and the US. PE investors typically look for key shareholders who are active in the business to roll over part of their equity stake as part of the transaction. Care is needed in relation to the tax consequences for shareholders of the transaction including considering the treatment of share options whether exercised or cancelled for consideration, rollover provisions and earnout payments.
Typically, employees will, post the transaction, acquire separate classes of shares – “strip equity” on the same terms as the PE investor and “sweet equity” a separate class for management akin to a growth share. It is important to consider the Irish tax treatment of these shares including the valuation of same and whether any tax arises on acquisition. The specific rights attaching to these shares will influence the value of the shares but may also impact on the future tax treatment of the sale of the shares. There are numerous considerations when structuring these rights, and the commercial objectives can sometimes conflict with the intended tax consequences. Obtaining advice in advance is recommended, either for sellers to best represent their interests or for buyers to ensure tax compliance and a well-designed incentive for management post transaction.
Conclusion
As companies strategically drive towards an ultimate sale they should be considering whether a share plan or plans will help in the achievement of that strategy. Allowing key management to own shares is often a prerequisite to attracting and retaining key talent. Taking the time to establish the right plan at an early stage will pay off in the long term.
