In the broader context of business planning, capital raising and generally adapting to the economic shock of COVID-19, re-assessment of existing employee share plans should be pro-actively managed, to ensure the implications of workforce reductions are fully understood and key personnel are appropriately engaged to remain fully on board for the journey.
In this fourth article in a series called ‘Navigating Volatility’ we highlight some key issues arising from changes to employee share plans that are likely to be contemplated in this environment. These issues should always be considered holistically, seeking appropriate professional advice on each of the interconnected legal, tax and accounting implications in each of the jurisdictions in which there are participants. This article makes reference only to certain Australian law issues.
When viewed as a whole, care needs to be taken to ensure the package of changes are not so fundamental as to be deemed a disposal of the plan’s securities and issue of new securities from a tax perspective. In addition, if options are ‘out of the money’ (or a loan value exceeds the market value), tax consequences of amending the plan will also need to be carefully considered.
Whilst most plans will allow for the board to make changes (albeit in certain circumstances shareholder approval may also be required), these are typically limited to those that are not detrimental to participants. There are however limited circumstances in which these changes can be made that are not detrimental to participants. These typically include changes needed to comply with new tax or corporations legislation, to enable the participant to qualify for a tax concession or to correct any manifest error or mistake. Consider carefully, in these circumstances, whether the impact on the business caused by COVID-19 falls within one of those limited exceptions (such as it being a ‘material adverse change’).
Before implementing changes to your plan, these should be reviewed against all relevant legislation to ensure that any concessional tax treatment and other attributes remain available. This will require a review from both a tax and legal perspective.
During uncertain times, you may have employees that will be leaving the business, or you may be making strategic hires to help grow certain operations. In making decisions from redundancies to new hires, it is key to consider how those are, or will be, treated under the relevant ‘good’ and ‘bad’ leaver definitions. As a result of this analysis, it may be appropriate to amend the definitions going forward.
When issuing (or transferring from a leaving participant) securities, it is always crucial to consider early on the securities law analysis in each jurisdiction, in addition to the tax and accounting framework, which will together determine the types of securities to be offered and participant pool. In Australia, the securities law analysis involves compliance with all relevant provisions of Chapter 6 and Chapter 7 of the Corporations Act 2001 (Cth).
For participants in salary sacrifice plans, consider whether any ‘locked in’ quantum of salary sacrificed for a certain period needs to be released or paused in order to provide financial support.
If loans are to be provided to participants by a group company to fund the acquisition of their securities, as is common in the Australian market, the accounting treatment of such loans should be carefully considered, in addition to the nature of recourse against the participant. It is also key that the participant receives the loan directly, to minimise adverse tax consequences for the company and ‘financial assistance’ provisions of the Corporations Act 2001 (Cth) will need to be considered.
To keep participants motivated when performance hurdles (such as money multiples for financial investors, IRR targets or group sale targets) become so unrealistic as to become meaningless, these should be re-set. This decision involves other equity holders too (to ensure alignment with their cost of capital and expected returns). Accordingly, early engagement is advised.
If only a particular business unit’s performance is affected by the participant’s or team’s activities, consider the use of ‘tracker’ securities in a group plan to align that participant’s or team’s interests most directly to their individual performance. Alternative share rights such as these may also be appropriate to drive growth in a particular business unit, without needing to create a separate plan, in preparation for a carve out.
To align incentives with other shareholder returns where the time horizon may have been pushed out as a result of the economic challenges facing the business, you may also consider locking in key personnel to remain for the journey by extending the vesting period on their securities.
During times of stress, companies will invariably need to obtain additional funding, be it equity, debt or hybrid instruments. Whilst not typically anticipated, anti-dilution protection for participants will need to be considered, to fully understand the impact of the new funding on the capital structure.
If current participants are already shareholders and receive a (new or further) loan to fund the acquisition of their shares, this will result in certain features being required of that loan to minimise adverse tax consequences to the participant.
Subordination issues are also key, as new sources of funding may seek a preference, in which case it should be confirmed that such an issue is permitted without being deemed detrimental to the participants.
The shareholders agreement or constitution, governing the relationship between the company and its shareholders, should always be carefully considered when making any plan changes. Typically, key issues to consider include voting rights, especially for ‘reserved matters’, restrictions on transfer (‘tag’ and ‘drag’ provisions) and variation of share rights, together with any authorisations required to effect the changes to the plan (and any corresponding issue of securities).
In the case of listed entities, all relevant ASX Listing Rules and Guidance Notes will also need to be considered, together with industry guidelines. This will ensure that issues of new securities are made within authorised limits, appropriate disclosures are made, and terms are in accordance with rules and good governance guidelines.
The Corporate Team at Hamilton Locke is highly experienced in advising, in conjunction with leading tax and accounting practitioners, both private and listed companies in structuring their employee share plans. Please contact James Delesclefs or Cristin McCoy if you would like to discuss.