Incentivise Key Staff- EMI and other options involving share

ownership for employees

Breakfast Briefings: Winter 2017/189th January 2018

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Administration

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.

Presentations followed by discussion

Presenter Topic

Martin Brown

Tax Director, PKF Francis Clark

Employees and shares – designing a

long term incentive

Giles Dunning

Partner, Stephens Scown

Employees and shares – legal

matters

Richard Wadman

Corporate Finance Director, PKF

Francis Clark

Valuation of minority interests.

Employees and shares – designing a long term incentive

Martin Brown January 2018

Long Term Incentives

And Retention

• Shares can make a great incentive

• Incentive – Employee value directly linked to

shareholder value

• Long Term Retention – Value linked to Exit

• Low cash cost to business – funded by ‘buyer’

• Communication is key

• VALUE = PERCEPTION

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Long Term Incentive Plans (LTIP)

• Cash LTIP

• Share Ownership

• Deferred purchase

• Growth shares

• Share Options

• EMI plans

• CSOP

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Designing a share plan

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Things to think about

Focus on commercial needs, not the tax wrapper.

• Which employees/directors will participate, will more join in

the future?

• What is within their influence?

• What does good look like for the company/the individual?

• What are the shareholders trying to achieve in the long

term?

• What are your KPIs?

• Will the plan deliver a meaningful value of reward?

• How will the participant realise value from the award?

Tax

• It is EXCITING (honest)!!

• Right = 10%

• Wrong = 60.8%

(Very Wrong = Over 100%)

OK Maybe not exciting: but expensive and

complex

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Employees and Shares – Legal Matters

Giles Dunning, Partner

Stephens Scown LLP

Direct Employee Share Ownership

Key legal aspects:

• Immediate dilution of existing Shareholders

• Leaver provisions - Good Leaver

- Bad Leaver

• Facilitating an exit

• Tax advice needed – usually an immediate tax charge.

Dilution of Existing Shareholders

Example: Fred owns 100 Ordinary Shares of £1.00 each in

Quidditch Supplies Ltd (QSL). QSL issues 10 new Ordinary

Shares of £1.00 each to its Sales Director, George. Fred now

owns just under 91% of the Ordinary Shares of QSL and George

owns just over 9% of the Ordinary Shares.

Effects of Dilution – Voting Rights

In a Shareholder meeting both Fred and George would have 1

vote each on a show of hands. On a poll vote or written

resolution each share would carry one vote so Fred could cast

>90% of the votes.

Ordinary Resolution – Requires more than 50% of the votes

cast on a show of hands, poll vote or written resolution.

Special Resolution – Requires 75% of votes cast.

Conclusion – Fred has “control” and could remove George as a

director in a general meeting.

Effects of Dilution – Income Rights

• QSL wishes to declare a final dividend of £250 per Ordinary

Share (requiring an ordinary resolution)

• Fred would be entitled to a dividend payment of £25,000

• George would be entitled to a dividend payment of £2,500

• QSC’s retained distributable profit is reduced by £27,500.

Effects of Dilution – Capital Rights

• QSL is valued at £1m.

• The net proceeds after deducting the estimated costs of a

sale would be £925k.

• Fred would be entitled to circa £841,750 of the net proceeds.

• George would be entitled to the balance of the net proceeds -

£83,250.

• Fred’s ultimate share in the “equity” would be diluted by

£83,250.

Employee Departure

• Example: George receives an offer from Bludgers (South

West) Ltd, a key competitor. He decides to leave but wishes

to retain his shares in QSL.

• What can QSL do about this?

Leaver Provisions

• There are no provisions in the Companies Act 2006 or the

Model Articles requiring an employee to surrender their

shares on cessation of employment.

• Fortunately, Fred instructed his solicitor to amend the articles

of association of QSL prior to issuing shares to George.

• On reviewing the updated articles Fred finds a “compulsory

transfer” provision requiring a departing employee to offer

their shares back to the other Shareholders.

Good Leaver vs. Bad Leaver

• George accepts he is bound by the leaver provisions but

values his Shares at ‘at least £100k’.

• Fred consults the articles which include valuation

mechanisms for a “good leaver” and a “bad leaver”.

• A good leaver is entitled to receive a pro rata share of the

market value of the Company without discount for minority

interest.

• A bad leaver is only entitled to the par value of their shares

i.e. £1 per share.

Good Leaver vs. Bad Leaver

• A good leaver is defined as an employee who leaves by

reason of death, critical illness or ‘retirement’.

• A bad leaver is defined as a departing employee who is not a

good leaver.

• George changes his mind about leaving.

Facilitating an Exit

• Fred and George receive an offer from Nimbus 2000 Ltd of

£850,000 for the entire share capital of QSL.

• Fred wishes to accept the offer but George refuses as its

lower than the previous valuation of QSL. Nimbus threatens

to withdraw the offer if they can’t acquire 100% of QSL.

• Fred recalls his solicitor talking about drag and tag articles

being useful if he wishes to sell and consults to the articles

again….

Facilitating on Exit

• The articles contain a drag along clause stating that if the

holders of over 50% of the shares of QSL wish to sell, they

can compel the other Shareholders to join in the sale at the

same price per share.

• Confronted with the articles, George changes his mind and

agrees to sell.

Employee Share Options

• A legal right to acquire shares in the future at a set price

• Future dilution of existing Shareholders

• Vesting / exercise conditions

• Timing of exercise (exit only?)

• Tax advice needed – usually tax charge arises on exercise

• Consider whether the company can grant EMI options to

receive more favourable tax treatment.

Vesting / Exercise Conditions

• Time based vesting

• Performance based voting

• Time and performance based voting

• Keep it simple, objective and achievable.

Timing of Exercise / Exit Only Options

• Employee share ownership / dilution only occurs when

options are exercised.

• Exercise can take place immediately before an exit mitigating

risks of dilution (Exit Only).

• Share option rules can allow for cashless exercise of exit only

options allowing exercise price to be paid out of sale

proceeds.

Timing of Exercise / Exit Only Options

• Exercise notice (if executed as a deed) can appoint majority

Shareholder as attorney of the option holders to execute sale

documentation on their behalf.

• If share options can be exercised before an exit consider

direct share ownership protections as per above slides.

The information in this presentation is intended to be general information onlyand should not be interpreted as legal advice. English law is subject to changeso whilst Stephens Scown LLP seeks to ensure the information contained in thispresentation is up to date and accurate, the law can change quickly and noguarantee is made as to its accuracy which means the information should notbe relied upon. Presentation slides should not be viewed as an alternative toprofessional advice and Stephens Scown LLP does not accept liability for anyaction taken or not taken as a result of this information.

Disclaimer

Valuation of Minority Interests

Richard Wadman January 2018

Introduction

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• Valuation of shares in unquoted companies is not an exact science

• The only method to confirm any valuation is to complete an open market sales transaction. (*)

• Our indication is therefore purely our opinion on the amount that could be realised by sale of the shares in the current market.

• The appetite of buyers and market conditions change constantly, all of which may influence the value of the shares. (*)

• Others may place a different value on the shares

• Tax• define market value in accordance with s272 of Taxation of Chargeable Gains Act

1992 and associated relevant tax case law.

• (* = value or price?)

Methodologies

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• See handout in pack

• Company valuations• Discounted Free Cash Flow (Net Present Value)

• Net Asset Value

• Comparable Earnings (to arrive at Enterprise Value, then adjust to Equity Value)

• Minority shareholdings• Discounting future dividend income

• Company valuation, then apply a minority discount to a prorated value

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• Use when/ if:• Historic dividend income stream relevant to a minority shareholder

• Planned dividend income stream

• Calculation, requires assumptions on:• Dividends

• Discount rate

• Period (perpetuity or shorter?)

Discounting future dividend income

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• “The valuation must reflect the extent to which a potentialbuyer of the asset can control, influence and derive enjoymentfrom the asset. Usually, if the degree of control of the asset isless than 100 per cent, then the value of the percentage shareof the asset will be less than a pro-rata proportion of theasset’s total value. In terms of unquoted shares, there aremany degrees of control, usually determined by the votingpower of a particular block of shares. These range from fullcontrol, including power to liquidate the company, to a small ornon-existent influence over the company’s affairs of a minorityshareholding.”

• Published material indicates that for “small minority holdingsthe discount might be up to, say 90% if there is no expectationof return, either in the form of dividends or capital”.

Minority discounts

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• HMRC Share and Asset division guidance:

• …up to, say 90% if there is no expectation of return, either in the form of dividends or capital”.

Minority Discounts

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Valuations: basis used (c 100 valuations; out of 133 logged)

70%

8%

3%

6%

11%2%

Valuation basis

Enterprise Value (Comparableearnings)

NPV

DCF

Dividend yield

NAV

Recent transaction used asbenchmark

Incentivise Key Staff- EMI and other options involving share

ownership for employees

Breakfast Briefings: Winter 2017/18 Wrap up: Richard Wadman, Francis Clark 9th January 2018

Next…

Q&A and/ or discussion

• With opportunity for Q&A for presenters

• Discussion

Future presentations

• “Tomorrow’s World…” (06/02/18) – invite in pack

• “End of year tax planning ideas” (07/03/18)*

• Finance in Cornwall (18/04/18)

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