Strategic reward approaches to retain key employees and assure company’s success
July 03, 2020
In most company success stories it is all about employees’ commitment and therefore it is important to hold on to valuable employees to ensure the future development of the company’s business. Suvi Vänskä and Johanna Kannisto from Alder & Sound think that every start-up needs to have a strategic reward system for key employees and that planning of a strategic reward system should be started at an early stage of business. Besides start-ups, also investors need to have a good understanding of different employee commitment alternatives.
The design of the reward solutions must be comprehensive and strategy-oriented. Successful rewarding must take into account the objectives of both the company and the personnel, and at a tangible level, it must steer work in the desired direction. Reward indicators should therefore be linked to key indicators and objectives. The company’s employees can be committed and encouraged, by, for example, issuing shares of the employer company either for a fee or free of charge.
A variety of customized reward models enable committing employees in the organization cost-effectively and even achieving payroll cost savings. In the case of start-ups and growth companies, in particular, the possibility of an increase in value through ownership can act as an incentive to commit to a company despite the challenges of the development phase. This article briefly reviews few share-based employee commitment alternatives.
Employee stock options
Employee stock option refers to an employment-based right to receive or purchase shares of the employer company on pre-determined terms. Options will have a vesting date and an expiration date, and the employee cannot exercise options before the vesting date or after the expiration date.
The employee does not yet acquire taxable income with the acquisition of the stock options, but the options become taxable only when the employee exercises the options by subscribing to the company’s shares. In this case, the difference between the fair value of the share at the time of subscription and the total price paid by the employee for the shares and options is taxed as the employee’s earned income. The benefit to the employee consists of the opportunity to subscribe to the company’s shares at a price lower than the fair value and thus to benefit from the increase in the value of the share after receiving the option.
Personnel share issue
Personnel share issue can be carried out as a directed share issue, in which the shares issued by the company are directed to be subscribed by a limited number of subscribers. The directed share issue constitutes an exception to the shareholder’s initial pre-emptive right to the shares to be issued in the share issue in proportion to their ownership and therefore requires a particularly compelling financial reason. Incentive schemes for the company’s management or employees, for example, can be considered a particularly compelling financial reason.
The government has issued a proposal to add provisions to the Income Tax Act regarding the possibility for unlisted companies to commit employees more effectively through personnel issue. According to the government proposal, employees could subscribe to new shares of the employer company without tax consequences based on the mathematical value of the share instead of the current 10% discount of fair value. This is a significant change in current legislation, as the mathematical value is generally lower than the fair value of the share and the reform has an impact especially on the personnel issues of growth companies.
The application of the regulation would require that the majority of employees have the right to subscribe to shares. The government proposal has been submitted to the parliament on 20.5.2020 and the new provisions are proposed to enter into force in July. If, on the other hand, the benefit is not available to the majority of the entire personnel, the taxable benefit is the difference between the fair value of the shares and the total amount paid for the shares. In this case, earnings-related pension contributions and unemployment insurance contributions must also be paid.
Remember the importance of a shareholder agreement
Shares received in an employee share issue may be subject to transfer restrictions. It is typical to draw up a shareholder agreement, which specifies in more detail the redemption of shares, for example at the end of the employment relationship, and other conditions related to the ownership and management of the shares. Various customized share series and the provisions of the shareholder agreement may also affect the valuation of the shares to be issued.
In addition, for each commitment alternative, it is generally advisable to seek a binding preliminary ruling from the Tax Administration.
Senior Associate, Head of Tax & Legal Services
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Partner, Tax & Legal Services
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About Alder & Sound
Alder & Sound has comprehensive expertise and experience in employee commitment and incentive arrangements from a tax, company law and employment law perspective. Alder & Sound also assist in valuations and in the creation of metrics, as well as strategic planning. Alder & Sound helps companies to find the best solutions for the company in a customer-oriented manner, taking into account changing regulations and current judicial practice.
Please note that while this article is meant to help you to identify some of the relevant aspects from Finnish law point of view, it is intended for general information purposes only and should not be relied upon as legal advice nor as a basis for decision-making.