equity incentives private companies - deloitte...3 today’s speakers: daryl hanberry partner, tax...

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

[email protected]

Sarah ConryDirector, Tax & Legal

+353 1 417 2374

[email protected]

Kelly PayneSenior Manager, Tax & Legal

+353 1 417 2831

[email protected]

Mary ShierDirector, Tax & Legal

+353 61 435542

[email protected]

Eamon DuffySenior Manager, Financial Advisory

+353 1 417 3918

[email protected]

Dympna CassidySenior Manager, Financial Reporting Advisory

+353 1 417 2982

[email protected]

mailto:[email protected]






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

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Page subtitle

Sarah ConryDirector, Tax & Legal

Why equity?



Benefits of equity incentives

Employee Retention

Employee Engagement

Employee Motivation

Competitive in the market

Performance Drive



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 plan design and implementation

Our team have extensive experience in drafting and implementing equity schemes and our services include the following as required.

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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)

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Kelly PayneSenior Manager, Tax & Legal

Equity Plans

Equity Incentives for Private CompaniesDeloitte Webinar January 2021

10

Share Options



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



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.


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Restricted Shares



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



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).


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Growth Share Plan



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



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.


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Key Employee Engagement Programme (“KEEP”)



Conditions to be satisfied


Qualifying

Company

Excluded

Activities

Qualifying

Share

Option

Group

Company

Limitations

Qualifying

Individual

KEEP Scheme

Main Conditions



Qualifying Company


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.



Qualifying Share Option


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



Qualifying Individual


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



• 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


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Mary ShierDirector, Tax & Legal

Legal Considerations



Legal Steps

Our team have extensive experience in preparing the corporate documentation to implement equity schemes.

The required steps are as follows:-

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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



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

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Eamon DuffySenior Manager, Financial Advisory

Valuations



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



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’



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



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.

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Daryl HanberryPartner, Tax & Legal

Closing Comments

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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

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Equity Incentives – Private Companies January 2021

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