They say that those that can do, indeed usually end up doing it for themselves. But owning and running your own business is often fraught with problems and not everyone who is capable really wants to share.
Yet inevitably, those staff that are good, very often require more than a bonus to keep them on board with you, and to help them to remain motivated for the duration.
One of the most attractive incentives for such ambitious people is a stake in the business.
Giving someone shares in your business is a massive step. Will they, for instance, attach value to a gift? In any case that inherent value to date has been created largely by you so why should you gift it? In addition the recipient of such a gift may well have to pay a Capital Gains Tax.
Alternatively you can sell some shares but minority stakes in businesses are always heavily discounted. If for example your business has a value of say £1m and you wish to sell 10% those shares will not be worth £100k. They are, at best likely to have a worth of £20k. So once again as the vendor you have taken a discount on something you have earned.
In addition when third parties hold shares in your business it also becomes essential to have a shareholder agreement to deal with disputes, death or even amicable partnership. This can be expensive and definitely takes time to negotiate.
There are of course share option schemes that allow you to give a beneficiary the option to acquire the shares in the future but at today’s value.
These have significant advantages, but can be expensive to establish and maintain. They work best, where shares have a market to trade in rather than a private company.
One scheme that deals with many of these negatives, such as cost and value, is a Phantom Share Scheme. These works as follows;
The company is valued (how, must be clear, but this is easily documented).
The aim then is to engage with the potential beneficiary, and encourage them to grow that value with either a planned exit date, when a third party will buy the shares or a fixed point in the future, when the shares will be valued again.
The beneficiary is then given a percentage; say 10% of that growth in value. For example if your company has a value at the start of this process of £1m and you sell or revalue the business in say five years and that value is now £5m the beneficiary will have 10% of £4m.
In other words they take no benefit from the initial value (why should they, they didn’t create it) but do benefit in the uplift.
The positives are it’s a simple contract that needs no revenue approval. Such phantom Shares have no dividend or voting rights and, if the beneficiary leaves before due date, no handover right. This makes it simple to manage.
The downside is the tax position for the beneficiary as such a gain will be treated as income.
There are ways to deal with this of course.
Practically the different between income tax and Capital Gains tax could be adjusted by the other shareholders or Company on payout or alternatively it just has to be accepted that’s how it is.
Indeed who can forecast what, if any, difference there may be in the future between and Capital Gains tax.
So if you want to incentivise your critical team but don’t want to “give too much away too soon“ Phantom Schemes are worthy of more thought.
Jo Haigh is head of FDS corporate finance services. Jo can be contacted on 01924 376 784 or firstname.lastname@example.org.