Giving someone shares in your business is a massive step. Will the recipient attach value to such a gift (especially when they may have to pay capital gains tax)? The inherent value of the company has been created largely by you, so why should you just hand shares over?
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 ten per cent, 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 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. This works as follows:
The company is valued (it must be clear how this is done, 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 ten per cent of that growth in value. Imagine, in this instance, that your company has a value at the start of this process of £1m. You sell or revalue the business in five years and that value is now £5m. The beneficiary will have ten per cent 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 that 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 the due date, no handover right. This makes it simple to manage.
The downside is the tax position for the beneficiary: such a gain will be treated as income. But there are ways to deal with this. Practically, the difference between income tax and capital gains tax could be adjusted by the other shareholders or company on payout.
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 01484 860 501/07850 475 878 or firstname.lastname@example.org
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