How to effectively reward key employees is a common vexing issue for private business owners. Unfortunately, salary alone doesn't always cut it. Owners are often looking for ways to bring employees into the equity structure of the business. That way, the key employee is rewarded for their "sweat with equity".
But as often as we have this discussion, we have a discussion about whether or not the business owner wants to pay tax on a transfer of shares to the employee.
The below solution in action will show you a scenario and one way we help clients solve this vexing issue.
SCENARIO
Hector Smith has been operating a successful earthmoving company for more than 25-years. Hector has built the business from the ground up, but his children have no interest in running the business. Hector has received a valuation of the business at around $6 million.
Hector does however have a large employee base, and several key employees have expressed interest in continuing the business should he retire.
Hector would like to take steps to introduce key employees to a structured program that allows key employees to be rewarded for loyalty, productivity, and participation in the business.
SOLUTION
As Hector operates the business through a company, Hector can amend the company's constitution to issue a special class of shares to the employee.
The special class shares would have "custom-built" rights attached to them which include:
Restricted voting rights;
Restricted capital and income distribution rights; and
Cessation of the rights after 47-months of their existence.
ISSUES
Issuing shares in a company can have adverse consequences if the Value Shifting CGT provisions are activated. In effect, the Value Shifting provisions are about stopping a shift of value from one shareholder to another without market value consideration (and tax) being paid.
This special class of shares must be issued and implemented in a manner that does not activate these provisions.
If the company is land rich (owns a large amount of land), stamp duty needs to be considered for your state.
OUTCOME
The directors of the company can issue dividends on the special class of shares to reward employees for their loyalty and their contribution to the profit of the business.
With the employees now holding the special class of shares.
This will give the employees access to build the funds required to eventually "buy out" Hector from his business in the long term. Whether in small pieces or in one lump sum down the track.
It should be noted that the issue of special class shares can be used just as a tool to reward employees not only in the event succession planning of the business.
BENEFITS
Employees will be more likely to see the business as a way to generate their wealth and will more likely wish to invest more effort and money into the business, which should increase the loyalty and the profit of the business.
The issue of a special class of shares may allow key employees to "stand out" from the rest and show themselves as the future leaders and controllers of the business.
UNIT TRUSTS
This same process can work for Unit Trusts, by issuing a special class of units. Similarly, stamp duty would only be payable on Unit Trusts that are considered to be land rich for their relevant state.
KEY TAKEAWAY
Issuing a special class of shares is a great way to reward and incentivise key employees, and a good way to scope out the next generation who could take over the running of your business.
By rewarding key employees, the business may see an increase in productivity and profits as the employees take a more active role.
Please contact us if you would like to talk to one of our specialist lawyers.