Essential ingredients to a successful investment

BLOG14th Jan 2014

In 2014, AAB’s Entry to Exit division foresee high net worth investors continuing to seek opportunities for significant return through investment in unquoted companies.

Derek Gemmell, a director with AAB, explains that in his experience two key ingredients are required for successful investments:

  1. An effective corporate strategy agreed on by investors and the existing shareholders; and
  2. A strong management team that is effectively incentivised to grow the business.

With these in place, management can work to achieve the strategy with their reward package constructed around such delivery.

Effective incentivisation for key management goes beyond salary, bonus and benefits package to encompass a reward linked to the company’s value. By doing this, management align their efforts with those of the shareholders to maximise growth – an objective which normally delivers an exit for the company shareholders.

However, many company owners make the mistake of awarding key management shares without investing time in documenting and sharing the corporate strategy and engaging management with it. They fail to understand that without clear communication of the company’s vision it is difficult for management to have sight to the potential worth of their award or when it is likely to crystallise.

Assuming a company has successfully documented and communicated its vision, incentivising a management team through ‘shares’ has many guises for employee share plans with tax breaks approved by HM Revenue & Customs to unapproved plans.

One approved plan, Enterprise Management Incentives (‘EMI’), is currently favoured by tax advisers for unquoted companies, given the availability of tax relief for the company providing the EMI and, since a recent relaxation in legislation, the more readily available 10% rate of CGT on disposal of EMI shares for the employee. However, unapproved plans are still worth consideration given their flexibility and relative simplicity, though this comes at a tax cost for the recipient employee.

One such plan, a phantom share plan, offers the following benefits:

  • With no detailed rules to comply with, a phantom plan brings great flexibility;
  • Real shares do not require to be issued to recipients;
  • It looks and feels to the employee like a share scheme with ultimate reward inherently linked to the value of the company’s shares, but for tax it is a deferred bonus scheme;
  • Reward level can be linked to other performance conditions as well as growth;
  • Low ongoing administration costs and manageable implementation costs;
  • The company is free to determine the method of valuation of the phantom shares;
  • Charting the value of award is straight forward and easily disclosed to staff.

A phantom plan’s less appealing characteristic is the tax treatment of the amount received by the employee on crystallisation; it is treated as a bonus and PAYE/NIC applied. Additionally, the company has to pay employers NIC on the crystallised amount but this is offset by a deduction against taxable profits for the ‘bonus’ and the Employers NIC.

Ultimately, the choice of share incentivisation plan will be driven by the objective of the owners and whether real shares are available to offer to staff. However, if shareholders wish to secure a management team to go the extra mile in delivering a rewarding exit for investors and shareholders alike, a shared corporate strategy is needed coupled to some form of share based incentive.

For more information contact Derek Gemmell, a Director with AAB, who is regularly involved in discussing corporate strategy with clients and advising on the range of alternatives for incentivising management as part of Entry to Exit planning for entrepreneurs.