Fiona Bell, Partner in RSM UK Legal LLP

The Great Resignation was perhaps the topic of the year in 2021, and continues to be a concern.  Incentivising our people has never been more important for recovery and growth as the public health crisis begins to abate in many markets.

Surging energy costs with fossil-fuel prices nearly doubling in the past year have boosted inflation, as well as rising food prices, particularly in Europe. The war in Ukraine has only worsened global inflation as it disrupts supply and increases military spending. According to the January 2022 World Economic Outlook Update from the World Economic Forum, inflation is likely to remain elevated, before subsiding next year.

These unprecedented inflationary pressures impact wages for highly skilled workers. This has been seen particularly across the technology, life science, finance and professional services sectors amongst others.  This has been felt internationally with remote working arrangements for COVID-19 proving that staff can be based worldwide. No enterprise, however successful, can overlook any approach to engagement of its people with equity incentives remaining a key part of incentivisation strategies for the future.

RSM is known for its focus on high growth and mid-market businesses, accounting for at least half the economy in our largest markets, and up to 70% of employment in the US and UK.  Historically, both of these economies have encouraged equity incentive schemes and are also amongst the first to be affirming a post-COVID-19 mindset in economic recovery.  In the UK, this appears to be based on high vaccination rates. In the US, perhaps influenced by the wish to get back to normal working life, with or without vaccination.

The US and the UK established share ownership as a common employee incentive as long ago as the 1960s. In the 1980’s the UK, publicised share ownership through the privatisation of state enterprises in energy, utilities, and transportation. In the US, this coincided with the launch of high growth SME technology businesses.  Elsewhere, specific tax relief exist for qualifying share plans, such as in France or stock options are familiar with a well understood tax position.

Despite some success, after a near half century we may reasonably question their efficacy, and structuring, especially as new generations enter the workplace, with different needs and macro-economic prospects and priorities.

Equity incentivisation is about engagement first, and tax second

Equity is not about tax, it is about engagement

Equity is not about tax; it is about engagement. Equity incentivisation, shares, stock, options, units or whatever, must have a business value for an organisation. The objective must be engagement, retention and financial encouragement to ultimately achieve goals and create growth, by whatever metrics are relevant to the business.  ESG (environmental, social and governance) factors have never been more important to employees and investors alike.

The value of hope in all our lives has been underlined by the challenges of the public health crisis.  Equity provides an emotional alignment of employees and management with the founders, owners, and outside investors.  Many successful companies have generated life changing wealth, even for mid-level staff.; This is reflected in global technology and life science businesses, along with partnership organisations in finance and professional services that provide equity awards in an unquoted environment.

Equity growth opportunities support founders to attract talent in high-risk start-ups, where funding often does not allow market rate salaries, and the success stories of the many unicorns (companies which become of $1bn plus value from start-up).

The primary structures which are common across jurisdictions

Around the globe there are differing approaches to share based reward, and we can see common key themes and concepts:
 

1. First, longer term gains are typically taxed on a favourable basis than income from employment. There may be an exemption up to a capped limit in some markets (such as the UK annual exemption and other reliefs), or a lower rate after shares have been held for a specified period (as in the USA when held for over a year) but essentially the employee shareholder can be treated on a par with founder and investor shareholders. 
    
2. Secondly, so called ´dry tax´ (where you are taxed on the value of the award before it becomes convertible into cash) can be managed to low levels or deferred until the gain is realised. For example, using growth shares. This facilitates an award limiting or removing immediate tax charges.  Options based on current market value are the obvious mechanism as many jurisdictions, for example Germany, do not usually treat the grant of these option as a taxable event.    Further plans have statutory tax advantages allowing share purchases and sometimes free shares to be awarded up to specified limits, such as Employee Stock Purchase Plans (ESPP) in the US, Share Incentive Plans (SIP) in the UK and Plan d’Epargne Enterprise (PEE) in France. 
    
3. Thirdly, there are a range of jurisdiction specific schemes such as the EMI (Enterprise Management Incentive) scheme in the UK, Incentive Stock Options (ISOs) in the US,  Qualified Stock Option Plan in France and save as you earn (SAYE) Plans in Ireland, which allow the award of equity at no cost to the employee and treat the gain as capital.

Internationally, these common elements provide relief for both the employer and employee against employment taxes and social security contributions, which expected to rise significantly in the coming tax years, in part to balance the costs of combatting COVID-19. The cost of providing equity to employees may also be deductible company’s profits subject to corporation tax liability; and where corporation tax has high rates this offset is more valuable.

In high growth markets such as China and India, there are both challenges and opportunities.  According to Reuters, in 2020 500 domestic public companies in China disclosed that they deployed equity incentive plans, though there are tight restrictions on international companies in that market, and usually these are only essayed by global majors listed on a public stock exchange. 

In India and South Africa currency restrictions limit the scope of schemes but it is still possible to include employees in the plans established by international groups.

Global plans giving consistent awards to worldwide employees are commonplace and can meet the needs of the mid-market expanding internationally.

What can equity schemes offer Gen Z in the War for Talent?

Throughout the world, the next generation of talent has a set of challenges: ensuring work-life balance for professionals; real estate hyperinflation, from Shanghai to San Francisco; and a reduction in the comfort of final salary pension schemes. Perhaps these place a premium on cash compensation in the earlier career years. 

Even so, new talent wants to join businesses to which they have a genuine ideological attachment; to be genuinely part of something; and bringing with them a zeal to change the world through their work.  This positions them well to seek alignment and engagement in the form of equity as part of their package. This is a two-way benefit creating opportunities for financial reward and ensuring a bond with their company and long-term retention. 

We see in our practice endless examples of equity lock-ins for young talent valued by both parties to the contract, and collateral extensions of length of service.

Conclusion

We always look in our advice for outcomes which work for employers and employees, based on mutual interest, and at the end of the day that is based on commercial and staff success in harmony, and leverage of the incentives provided by the relevant jurisdiction in the common interest.  That is likely to mean increasingly bespoke packages for talent at every stage, increasingly based on drivers beyond the economics.