Private company valuations and equity reward opportunities
18 Jun 2020
Due to the economic impact of the Coronavirus pandemic on the UK economy, the value of some private companies may have fallen. These falls could impact on existing share plans (such as EMI and growth share plans). In addition, in light of likely reduced future cash bonuses and salaries, there may also be an opportunity to reward key staff with tax efficient equity incentives.
Usually no income tax or National Insurance contributions (NIC) are payable when an employee exercises an EMI share option.
Companies that may not have even considered granting EMI options to employees may want to start thinking about doing so, when a stake in the equity might be an attractive alternative to a cash bonus. Employers may be able to agree lower share valuations with HM Revenue & Customs (HMRC) for the granting of the new EMI options.
For companies that have already granted EMI options, particularly those where the exercise price is higher than current market value, they could consider inviting employees to surrender their options and issue new options over shares at the current new (lower) market value. As future cash bonuses and salaries are likely to be reduced going forward, reducing the employees’ future cash outlay on an exercise of their options can be used as a tax efficient alternative. The employees and employer would need to consider the resetting of the two-year holding period for Business Asset Disposal Relief (BADR – previously Entrepreneurs’ Relief) and associated professional costs.
Finally, some EMI plans may have vesting criteria, which is dependent on the enterprise value on an exit and consideration could also be given as to whether those conditions be varied. A variation to an existing option agreement could be treated as a grant of a new option and specialist advice should be obtained.
It is possible that profit forecasts used to prepare the initial growth share valuations and set the hurdle level, may now be overly optimistic and have been revised downwards. With the hurdle level potentially now significantly in excess of the current company’s value (and therefore the employee’s equity of limited value to them), employees may see little incentive to remain with the company, or to grow the business and push it forward (outside of any cash bonus they may receive).
Employers could therefore look at their existing growth share plans and undertake a new valuation based on revised forecasts. In light of a lower valuation, consideration could then be given to changing the hurdle threshold or issuing new shares with the lower hurdle.
As noted above, future cash bonuses and salaries are likely to be reduced in the immediate future, therefore the use of improved equity reward plans provides a tax efficient reward with no cash outlay for the employer.
There are various tax implications to consider when changing share rights and there will also be the professional costs of preparing new valuations and updating documentation.
Similar issues may apply to highly leveraged companies with underwater equity (ie now worth less than its initial value), and consideration could be given to capitalising or writing-off shareholder debt or changing the terms of the debt. There are again various personal and corporate tax issues that would require detailed consideration.
In an environment where future cash bonuses and salaries are likely to be reduced in the immediate future, the use of improved equity reward plans can provide a tax efficient reward for the employee with no cash outlay for the employer.