Equity IncentivesPrivate Companies
Deloitte Webinar – January 2021
22
Daryl HanberryPartner, Tax & Legal
Welcome
33
Today’s speakers:
Daryl Hanberry Partner, Tax & Legal
+353 1 417 2435
Sarah ConryDirector, Tax & Legal
+353 1 417 2374
Kelly PayneSenior Manager, Tax & Legal
+353 1 417 2831
Mary ShierDirector, Tax & Legal
+353 61 435542
Eamon DuffySenior Manager, Financial Advisory
+353 1 417 3918
Dympna CassidySenior Manager, Financial Reporting Advisory
+353 1 417 2982
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 4
AgendaWelcome and Introductions
Thank you and Closing
Why equity?
Equity plans
Legal considerations
Valuations
Accounting
55
This is dummy text it is not here to be read it is here to show how this document will look.
Page subtitle
Sarah ConryDirector, Tax & Legal
Why equity?
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 6
Benefits of equity incentives
Employee Retention
Employee Engagement
Employee Motivation
Competitive in the market
Performance Drive
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 7
Points to consider
Designing an equity plan
Flexibility
Eligibility
Vesting
Conditions
Tax
Advantages
Change of
Control/IPO
Good
Leaver/Bad
Leaver
Equity Plan Design
Considerations
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 8
Equity plan design and implementation
Our team have extensive experience in drafting and implementing equity schemes and our services include the following as required.
8
Plan
Design
Drafting Term Sheets
Valuations
Advice on Company Law & Accounting
Considerations
Plan Implementation
Employee Communication
Management
Partnering with Plan
Administrators
Revenue Approval
(if required)
99
Kelly PayneSenior Manager, Tax & Legal
Equity Plans
Equity Incentives for Private CompaniesDeloitte Webinar January 2021
10
Share Options
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 11
Overview
Share Options
A Share Option is the right to acquire shares at a specified price at a future date.
Advantages
• Do not have to be granted at market value so no valuation required. This makes it easy to grant options at any time
• Employer PRSI saving
• Easy to implement
• Performance & retention criteria can be built into vesting conditions.
• Vesting can be linked to an “event” if required e.g. sale or IPO
• The employer has flexibility as to whom options are given to
• No share ownership until exercise – reduced risk for employees
• Employee has flexibility to decide if and when to exercise the option
Disadvantages
• Not tax effective – Income tax, USC and Employee PRSI payable on exercise
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 12
Where to begin
Share Options
Consider what the exercise price will be. This does not have to be market value so flex for the company in determining this.
Set the vesting conditions. These can be time based, performance based or a combination of both. It can also be set that options will vest on an “event” i.e. sale, IPO, change in control.
Consider the position for leavers and whether:• - all would relinquish if cease employment before vesting or exercise; or • - will there be good leaver provisions.
Draft plan rules to implement the plan in line with the set objectives.
Equity Incentives for Private CompaniesDeloitte Webinar January 2021
13
Restricted Shares
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 14
Overview
Restricted Shares
A Restricted Share is a share which is restricted for a set period of time. It must be held in Trust and cannot be assigned, sold or utilised as security during the restricted period
Advantages
• Incentivise key employees to grow the company
• Taxable value will be reduced by reference to the restricted period. 10% reduction per year to a maximum of 60%. Where shares are restricted for greater than 5 years the employee will be taxable on 40% of the value of the shares (assuming they don’t pay for the shares)
• Capital gains tax payable on the disposal of the shares. The base cost for CGT will depend on whether the shares were newly issued or pre existing on award
• Flexibility in determining rights attaching to the shares and good/bad leaver provisions
• No ongoing valuations required – once off upfront valuation
Disadvantages
• Owned from day 1 – employee takes on risk of share ownership
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 15
Where to begin
Restricted Shares
Establish the Market Value of the company and the value of a share being awarded.
Determine the period of restriction to apply and the trust arrangements.
Issue shares to the Trust on behalf of the employee with the relevant documentation in place as required by tax legislation.
Employees pay tax on the abated value of the shares (assuming they don’t pay anything for the shares).
Equity Incentives for Private CompaniesDeloitte Webinar January 2021
16
Growth Share Plan
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 17
Overview
Growth Share Plan
A Growth Share is a share with restricted rights based only on the future growth of the company above a specified level.
Advantages
• Incentivise key employees to grow the company
• Lower upfront value than an ordinary share so reduce upfront cost for the employee
• Existing shareholders retain the value already built up in the company
• Capital gains tax payable on any growth in the shares (payable on a disposal of the shares)
• Flexibility in determining rights attaching to the shares and good/bad leaver provisions
• No ongoing valuations required – once off upfront valuation
Disadvantages
• Only participate in future growth in the company/value above hurdle
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 18
Where to begin
Growth Share Plan
Establish the Market Value of the company and set the “hurdle” for the Growth Shares. Participants share in the value above this hurdle.
Determine the rights attaching to the Growth Shares i.e. generally no voting rights and may not have dividend rights. Determine the market value of a Growth Share.
Issue Growth Shares to employees and existing shareholders. The employees are issued with a % of the Growth Shares with the remainder being held by existing shareholders.
Where employees pay market value for the Growth Shares no tax arises on acquisition. If employees pay less than market value for the Growth Shares a taxable benefit arises.
Equity Incentives for Private CompaniesDeloitte Webinar January 2021
19
Key Employee Engagement Programme (“KEEP”)
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 20
Conditions to be satisfied
Key Employee Engagement Programme (“KEEP”)
Qualifying
Company
Excluded
Activities
Qualifying
Share
Option
Group
Company
Limitations
Qualifying
Individual
KEEP Scheme
Main Conditions
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 21
Qualifying Company
Key Employee Engagement Programme (“KEEP”)
Qualifying Company
• Irish or EEA incorporated and Irish resident or if EEA resident carries on a business in the State through a branch or agency
• Exists wholly/mainly for purposes of carrying on a qualifying trade on a commercial basis
At Grant
• < 250 employees and either turnover not more than €50M and/or a balance sheet not exceeding €43M; and
• The total market value of the issued but unexercised qualifying options does not exceed €3M.
Throughout Grant to Exercise Period (not < 12 mths)
• Unquoted with none of its shares quoted on unlisted securities market other than Enterprise Securities Market or a similar stock exchange in EEA or treaty country; and
• Not regarded as in difficulty for the EU Commission Guidelines on state aid.
Qualifying Company
Excluded Activities:
• Dealing in Commodities or futures in shares, securities or other financial assets
• Financial activities
• Professional services
• Dealing in or developing land
• Building and construction
• Forestry, and
• Operations in the coal industry or steel and shipbuilding
Professional Services:
• Services of a medical, dental, optical, aural or veterinary nature
• Services of an architectural, quantity surveying or surveying nature, and related services
• Services of accountancy, auditing, taxation or finance
• Services of a solicitor or barrister and other legal services, and
• Geological services
Shares is a holding company may qualify provided the subsidiary meets all the conditions and the holding company does not carry on a trade. Effectively there is a requirement that the holding company’s business consists wholly or mainly of the holding of shares in qualifying subsidiaries.
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 22
Qualifying Share Option
Key Employee Engagement Programme (“KEEP”)
New, ordinary fully paid up shares in qualifying company
No preferential rights to dividends, assets on a winding up or redemption
Written contract outlining terms and exercise price at least equal to market value on grant
Cannot be exercised within 12 months except in limited circumstance or more than 10 years post grant
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 23
Qualifying Individual
Key Employee Engagement Programme (“KEEP”)
Qualifying Individual
Overriding limit: cannot exceed 100% of
remuneration in a year
Work at least 20 hours per week or 75% of their
working time
If satisfy the conditions to date of cessation
exercise within 90 days
Cease to qualify if exceed this 15% limit
€100,000 in a year or €300,000 over 3
Fulltime employee/director in a
qualifying company
Cannot own, directly or indirectly, more than 15% of the company
Office or employment capable of lasting > 12
months
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 24
• Option granted 11 October 2019 to buy 10,000 shares at €1 per share. Market value of shares at date of grant is €1 per share.
• Option exercised 11 October 2021, 10,000 shares purchased at €1 per share. Market value at date of exercise is €2 per share.
• Shares sold 11 October 2022, 10,000 shares sold at market value of €3 per share.
• Individual’s employment income (excluding options) is in excess of €70,044.
Results in a 19% tax saving on the gain at exercise and the full tax liability is deferred to the date of sale.
Non-KEEP Options KEEP Options
Liability at Grant N/A N/A
Liability at Exercise €5,200 (52%) N/A
Liability on Sale €3,300 (33%) €6,600 (33%)
Total Tax Liability €8,500 €6,600
Key Employee Engagement Programme (“KEEP”)
2525
Mary ShierDirector, Tax & Legal
Legal Considerations
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 26
Legal Steps
Our team have extensive experience in preparing the corporate documentation to implement equity schemes.
The required steps are as follows:-
26
Review the existing share capital structure and create new shares
Amend the constitution to incorporate the rights for the new share classes as agreed between the parties
Convene director and shareholder meetings to approve and adopt the new constitution and allot the new shares
Update the statutory registers and make the necessary filings with the Companies Office
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 27
Overview
Constitutional Changes
• Authorised share capital
• Create the share class or classes
• Include the rights for each share class:-
• Dividends
• Voting
• Return on wind up or shareholder exit
• Transfer or Redemption provisions on death in service
• May refer to separate agreement if performance related
• Shareholders Agreement impact
2828
Eamon DuffySenior Manager, Financial Advisory
Valuations
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 29
Aim is for a collaborative pro-active approach that aids your planning of the Equity Incentive
Steps in the valuation process
Understanding and discussing the Equity Incentive’s terms
• Discuss the intent behind the Equity Incentive, map out its rights and encumbrances, and, in particular, the impact any other class of shares or incentives may have on it
01
Value the overall business
• On a Fair Market Value basis, establish the value attributable to a 100% equity level value for the business (i.e. value after adjustment for surplus assets, debt and debt like items)
02
Value the Equity Incentive itself
• Value the Equity Incentive using complex valuation techniques that are compliant with Irish Tax rules and any relevant accounting standards (e.g. IFRS 2 or ASC 718)04Discussion of valuation results
• Presentation and explanation of the valuation and its key drivers
• Level of deliverable tailored to your needs (i.e. Valuation Letter or standalone Valuation Report)
• Scenario analyses and discussion re key terms can have strong impact on the valuation without tainting the attractiveness of the Equity Incentive
05
Application of any tax reliefs
• Discounts for lack of control (DLOC) or lack of marketability (DLOM) may be appropriate
• Level of discounts can be based on guidance from Revenue or based on various financial theories03
Our goal is to provide a bespoke service that helps you articulate and design the best Equity Incentive plan for you and your business
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 30
Appropriateness of methodologies will change as the business develops and matures
There is no one perfect method, preference is to apply multiple approaches and triangulate on value
Methodologies for valuing the overall business
Capitalisation of earnings (i.e. multiple of earnings such as EBITDA)
Single DCF
Cost
Venture Capital Method
Non-financial market multiples
Scenario weighted DCFs
Transaction/ Funding round
Milestone driven transaction / funding round
Investment Revenues
Seed Series A Series B Series ‘X’
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 31
Methodologies for valuing the overall business
Equity Incentive Methodology Key Inputs Pros - Cons
1. Option Pricing Model
• Very common approach, rooted in statistical /
mathematical formulae applied in trading (e.g.
Black-Scholes or Binomial / Lattice Method)
• Each equity class treated as a Call Option on overall
Equity Value
• Equity Value
• Risk Free Rate
• Time to Exit
• Volatility
Most appropriate where Equity Incentive includes a form of “optionality”
Finite number of inputs, most of which can be audited back to observable market data
– Relatively opaque/”Black Box” nature
– Highly sensitive to inputs applied
– May not be appropriate for complex scheme
2. Probability Weighted Expected
Recovery Method
• PWERM, is a Waterfall based technique, capable of
incorporating multiple scenarios
• Multi-step process where value estimated based on
the probability-weighted present value of various
future outcomes (IPO, sale, steady state or
dissolution)
• Equity Value
• Future Scenarios
• Probabilities
Capable of modelling and reflecting Equity Incentives with complex terms / payoffs
Relatively transparent as flowthrough the “waterfall” can be traced / discussed
– Requires that potential outcomes can be identified, their probabilities predicted and outcomes be expected in the near-term
3. Simulation / Monte Carlo
• Highly complex approach, rooted in Geometric
Brownian concepts, Monte Carlo most famous form
• Capable of reflecting highly complex situations or
Equity Incentives (scheme payoff depends on
multiple metrics at multiple dates)
• Equity Value
• Normal Distribution
• Standard Deviation
Can solve for highly complex situations Incorporates all future potential outcomes for the business and, in turn, the Equity Incentive
– Most complex method to apply
– Requires specialised software to apply
– Highly opaque in nature
3232
Dympna CassidySenior Manager, Financial Reporting Advisory
Accounting
Equity Incentives for Private CompaniesDeloitte Webinar – January 2021
© 2021 Deloitte Ireland LLP. All rights reserved. 33
Key Accounting considerations
Scope
The first important step when assessing the applicable accounting treatment for an incentive plan is which standard should be applied.
Classification
On the assumption that this falls within the scope of IFRS 2 your next step is based on whether the awards are cash settled, equity settled or a combination of the two.
Disclosures
IFRS 2 and the Irish Company Act disclosures.
There are instances where such awards can fall within the scope of additional related party transaction disclosure - “key management personnel”.
Recognition and measurement
Careful consideration of the terms and conditions of each plan is required to ensure that the plans are correctly recognised and measured for accounting purposes within the statutory financial statements.
Impact upon the statutory financial statements.
3434
Daryl HanberryPartner, Tax & Legal
Closing Comments
35
Equity Incentives
Design & Feasibility
• Incentive design labs
• Development of strawmen and support with stakeholder management
• Support with administrator selection
• Tax & legal feasibility
Tax, Legal & Accounting
• Tax & legal actions
• IFRS2 / headroom modelling
• Share plan financing
• Corporate tax deductibility
Implementation
• Operational policies / processes
• Preparation of plan documents by our legal team
• Pre-launch registrations and filings
• Developing a communication strategy
Launch
• Training for local payroll / HR
• Rolling out a successful employee communication strategy
Ongoing Operations
• Ongoing employee communications
• Ongoing filings / non-payroll reporting
• Enhancements / adjustments feeding back into re-design
• Ongoing legal support
DesignDeliverDrive
Deloitte IncentivesHow we can help you...
Thank you for attending
Equity Incentives – Private Companies January 2021
At Deloitte, we make an impact that matters for our clients, our people, our profession, and in the wider society by delivering the solutions and insights they need to address their
most complex business challenges. As the largest global professional services and consulting network, with over 312,000 professionals in more than 150 countries, we bring world-class
capabilities and high-quality services to our clients. In Ireland, Deloitte has over 3,000 people providing audit, tax, consulting, and corporate finance services to public and private
clients spanning multiple industries. Our people have the leadership capabilities, experience and insight to collaborate with clients so they can move forward with confidence.
This publication has been written in general terms and we recommend that you obtain professional advice before acting or refraining from action on any of the contents of this
publication. Deloitte Ireland LLP accepts no liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.
Deloitte Ireland LLP is a limited liability partnership registered in Northern Ireland with registered number NC1499 and its registered office at 19 Bedford Street, Belfast BT2 7EJ,
Northern Ireland.
Deloitte Ireland LLP is the Ireland affiliate of Deloitte NSE LLP, a member firm of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”). DTTL and
each of its member firms are legally separate and independent entities. DTTL and Deloitte NSE LLP do not provide services to clients. Please see www.deloitte.com/about to learn more
about our global network of member firms.
© 2021 Deloitte Ireland LLP. All rights reserved.