Share Schemes supplement 2004: Cover story – Staff can feed from peaks and troughs

Implementing an approved share scheme across your workforce requires an abundance of time – not simply the three months that Inland Revenue experts recommend for obtaining tax approval. Such consents are in fact the last pieces of the jigsaw that can see employers take as long as a year to complete (in the case of larger and more complex plans).

One of the first steps should be to select a suitable adviser from the abundance of employee benefits consultants or the larger accountancy and law firms that specialise in this area.

This adviser will play a crucial role in drawing up the plan rules, ancillary documentation and in the case of a share incentive plan (Sip) – which requires setting up a UK trust – deeds of trust need submitting to the Inland Revenue. But it can also assist with many other processes that must be carried out before approval can be granted.

Obtaining shareholder approval is one of these. If your share scheme will be issuing new shares this is essential and even if it isn’t, it is still good practice from a corporate governance point of view. So it must be put on the agenda at a firm’s annual meeting (AGM) or, if there has been a merger or other special circumstance, an extraordinary general meeting (EGM).

Julian Foster, director of Halifax Corporate Trustees, says: “Ideally you should have an adviser in place six months before the AGM. Shareholder and board approval should be secured for the widest possible set of rules, which will basically allow you to adopt any structure you want. To get Revenue approval for a Sip you must have also selected a trustee and generally this is the same firm as the administrator. It is therefore often necessary to select your administrator first.”

Most share schemes use external administrators, and advisers can help to select these by putting forward a suitable short list to be subjected to a beauty parade. Furthermore, both the plan’s administrators and the advisers can provide valuable input into drawing up a draft communication plan, which is also required when applying for Inland Revenue approval.

But an administrator cannot be appointed until you have actually decided what type of share scheme you wish to introduce. So this is an immediate priority. Some companies address the issue before appointing an adviser whereas others rely heavily on their adviser during the decision making process.

Most employers which have decided to offer an all employee share plan choose between a Sip or a sharesave scheme because both offer generous tax breaks. But Suzanne Hall, employee share plans manager at Lloyds TSB Registrars, emphasises that: “HR directors need to establish how they believe employee share ownership can be used to align the interests of staff with the strategic objectives of the organisation. This also means thinking about how employee share ownership fits in with their existing organisational culture, the profile of the existing workforce, and also any wider strategies for recruitment and retention.”

She points out that companies listing on a UK stock exchange will, for example, usually consider this an apt time to implement an all employee share plan. “Those wishing to give employees an opportunity to experience owning shares for the first time may well opt for the Sip because it enables the employer to make grants of free shares. The same applies to those organisations who are trying to foster a high performance culture because Sips allow these awards of free shares to be linked to business performance.”

Nevertheless sharesave schemes, which were introduced in 1980, involve less risk than Sips, which only date back to 2000.

With sharesave, staff acquire shares from post-income tax and NI money, but they are signing up for an option rather than a share. Staff are in a no-lose situation because there is no share price risk until an option is exercised. After the three, five or seven year saving period staff can choose to get their money back (plus interest) rather than exercise their options if share price has fallen. If, on the other hand, the shares go up in value, then they enjoy the upside.

Sips offer the advantage of being purchased from salary before income tax and NI is deducted, but provide less security because they involve employees assuming risk for the shares’ performance. They are more complex to design and administer than sharesave schemes, offering a choice of several different types of shares.

Employers which choose a Sip can reduce the risk to staff by offering free shares or by matching what they spend on partnership shares. But this increases costs.

A further downside of Sips is that employees who leave the scheme within five years fail to enjoy the full benefit and five years can be a long time in sectors with a high turnover of staff. Sharesave, on the other hand, offers the opportunity to opt for only a three-year tie-in period.

Sharesave is always likely to be popular for companies with a lot of low paid staff who simply cannot afford to take risks with their regular savings. But when an organisation is committed to an equity culture and its competitors already have a Sip then it will probably have little alternative other than to introduce one.

For the many organisations that fall between these two extremes the cost of offering the different types of scheme will probably be a major factor. Both types of scheme are likely to involve set-up costs of at least £10,000, but when it comes to ongoing charges, sharesave schemes tend to be the cheaper option.

Sharesave schemes usually have only minimal administration charges and those with over 500 employees tend to have none at all. This is because the administrators hold the money contributed for a fixed period of time and earn interest on it.

With Sips, on the other hand, the administration charge for a plan offering all types of shares would typically be around £15 per employee per year. Sips can also involve more effort and expense in plan design as they involve far more variables on the standard theme than sharesave.

Offering either type of scheme will also involve significant communication costs. These are far more difficult to quantify but are likely to be higher for a Sip because it is more complex to explain and has risk warnings that must be spelt out.

But new accounting charges due to take effect from next January will give Sips a cost advantage over sharesave schemes. Employers will have to value all share options and share awards to employees through the profit and loss account so sharesave schemes, which tend to award options at a 20% discount, will be the worst hit. Sips do not award shares at a discount although matching shares and free shares will have to be taken off of the profit and loss account.

Carol Dempsey, reward and compensation partner at PricewaterhouseCoopers, says: “Potentially a Sip could have a lower cost if you give a limited number of free shares. We suggest that employers model potential costs and take them into consideration along with their reasons for providing the scheme. Are they, for example, offering a scheme because everyone else does or because they want to increase employee shareholding?” She suggests that employers consult with staff on this. “One way of getting an honest opinion is via a focus group, which can be conducted by an external agency.”

Dempsey points out that Sips can cost more to administer and communicate but if you look at the company in the round it will depend on its circumstances, such as whether it makes profits, pays corporation tax and what the turnover of staff is. “The shorter the turnover, the more expensive for employers Sips potentially become and the less attractive to employees. But they can still be more advantageous if the share-price increases significantly and this is the big unknown you must build in. Typically, you would take into account likely share price movements and if it seems the best solution over a reasonable range of these you would tend to go for it,” she says.

Having established the type of scheme required, potential administrators should be assessed in terms of their track record and experience, long-term commitment, communication services and operational efficiencies. Cost is obviously an important factor and, for this reason, it can be a mistake to opt for a Sip administrator simply because it already administers a company’s sharesave scheme, unless it can offer cost benefits for doing both.

Once the administrators are in place and have linked up their systems with the company’s payroll systems, the primary emphasis switches towards implementing the communication plan. Online communication can work if a workforce is computer literate, but for the shop floor worker, seminars or explanations via line managers are likely to be more effective. Thought should be given as to which people staff would feel most comfortable asking questions to.

Verbal and written explanations should be in simple language and documents should be of an appropriate size. An A4 folder, for example, is not necessarily suitable for workers who don’t sport briefcases, who may want something to fold up and put in their pockets.

Peter Mitchell, senior consultant at Watson Wyatt, says: “A classic mistake is to spend all the money designing the plan but to forget to communicate it, and because Sips are new, relatively complex and involve potentially greater risk, they tend to need a greater communication effort. There is no doubt that communication can have a huge impact on take-up rates and one should be aiming to achieve a take-up rate of 100% with free shares and of around 40% with partnership shares.”

Sip share choices
Employers implementing a share incentive plan (Sip) have four different types of share awards to consider during the scheme design process.

1. Free shares
Up to £3,000 of free shares may be awarded to each employee each tax year. Awards can be linked to performance.

2. Partnership shares
Employees are provided with the opportunity to invest pre-tax salary in shares and then sell those shares after five years without any tax to pay. Staff can spend up to £1,500 or 10% of salary – whichever is lower – to purchase partnership shares each tax year. The amount can be funded as a one-off payment such as a cash bonus as well as from normal salary.

3. Matching shares
Employers can give a matching award of up to two free matching shares for every one partnership share purchased.

4. Dividend shares
In addition, it is possible for up to £1,500 worth of dividends received in relation to plan shares to be reinvested in dividend shares each tax year.

Case study
When Legal & General introduced a share incentive plan (Sip) in April 2001 to complement its long-standing sharesave scheme it realised that effective communication should be a high priority.

The new scheme, available to all the company’s 8,000 UK employees and administered by Lloyds TSB Registrars, had received Inland Revenue approval the previous October and by the turn of the year the communication programme was well under way.

Colourful booklets were sent to staff, presentations were conducted at all UK locations and HR personnel were fully briefed.

But Meera Shah, assistant company secretary, stresses that it is not only the initial communication programme that has contributed to an 85% take-up rate. All offices receive a major presentation annually and, this year, employees were also alerted to the scheme’s three-year anniversary by a double page spread in the company’s in-house magazine and via a new dedicated intranet site, which was introduced in February.

Shah says: “The roadshows have been very successful because they give employees the opportunity to ask face-to-face questions and the numbers of hits we have received on the intranet site, which has a Q&A facility, has exceeded expectations.”