Giving employees equity in the business in recognition for good work is popular in some companies, for two reasons. First, it aligns the interests of the employee with the business even more. Second, it doesn't cost the business anything.
But they don't call it "skin in the game" for nothing. Those granted shares in an employee share scheme or otherwise have a host of issues to consider, ranging from taxation to currency to asset allocation. And if they fail to address them in a timely fashion, they might find themselves feeling the pinch.
While most listed companies lay claim to having some type of employee share scheme, they are usually focused on the executive ranks. At this level share schemes form a critical component of the salary package. Many will be forced to borrow to acquire them.
In today's business environment, however, where companies that didn't even exist 10 years ago can suddenly be worth billions of dollars, it has become more common for start-ups to offer them as a means of retaining staff.
Kel Fitzalan, private clients partner with PwC, explains the drawbacks of deferred benefits such as employee equity schemes, or "golden handcuffs".
"Given that there's no ready market for shares in unlisted companies, execs who work for them may be prevented from selling [their shares] until there's [an initial public offering or trade sale] deal," Fitzalan says.
Private firms tend to favour relatively uncomplicated share issues, while their publicly listed counterparts are more likely to use options that allow executives to buy shares at a discount at specific points over the short, medium and long term.
If you are employed by a multinational and live in Australia you will also have the issue of currency hanging over your head. Following a volatile few years for the Australian dollar, where it goes next is anyone's guess.
Andrew Moir is wealth management expert and a director of boutique wealth adviser Evans and Partners. He suggests executives who find themselves holding foreign equities flowing from employee share schemes should consider hedging up to 30 per cent of the total parcel.
"For every 1¢ the Australian dollar comes down the closer an exec should be to making a hedging decision," Moir advises. "They can lock in the currency, even if they can't lock in the price."
PROHIBITED DEALS
Hedging aside, executives are generally prohibited from dealing with their entitlements until they are eligible to execute the options, or otherwise vest the entitlement.
This includes the use of derivatives to create "cuff and collar" arrangements, which were used to protect against volatility in the lead-up to and during the global financial crisis, although these are seldom used today.
Once the risk of forfeiting the incentives ends and the entitlements become fully paid ordinary shares, executives will generally have greater flexibility in relation to their shares, including the use of options to protect against the potential of a share price rout.
Affinity Private chief executive Catherine Robson says great care needs to be exercised to ensure the use of derivative instruments complies with company policies, and don't cause executives to buy or sell shares in their employer outside prescribed trading windows.
For "ordinary" share scheme participants who aren't bank CEOs, for instance, concerns can be more practical such as having enough cash on hand to deal with the tax consequences or making sure the shares fit into your overall asset allocation and tolerance for risk.
"If well managed, there should be no adverse tax outcomes associated with employee share entitlements. And, for busy professionals with limited time, clarity around how these instruments fit within a broader personal investment strategy is essential," she says.
Instead of parking them in a bottom draw for future review, Robson argues that it's critical participants pay attention to the number and types of securities being issued, making sure to fully understand the tax outcomes of either and the potential for things to go wrong.
"There can be terrible outcomes where discretionary spending on holidays, cars, and home improvements are made in the expectation of employee share proceeds in the future," Robson says.
"Where entitlements don't vest or only partially vest it is possible to find yourself over committed when your employer is suffering from poor performance, which can be a perilous position to find yourself in."
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