Small business: Employee share schemes - Andrew Simmonds, Simmonds Stewart

Andrew Simmonds, a partner at Simmonds Stewart.

Andrew Simmonds is a partner at Simmonds Stewart, a corporate and commercial law firm for technology companies and investors.

Why set up an employee share scheme?

Employee share schemes are most commonly used in technology and high-growth companies. I see people in these sectors being interested in setting up these schemes as a way to attract, incentivise, retain and reward really talented people who are going to help a company grow. Those people are very aware of the trends and practices overseas in places like Silicon Valley and other tech hot spots, where employee share schemes are very common.

Anywhere there's an active startup or venture capital scene, employee share or option schemes are just a part of the landscape. Most of these early-stage companies assume they'll be giving up 10 per cent to 15 per cent of their shares in options granted to employees, directors and possibly some board advisers working for the company.

If you take the ultimate example of the benefits of these kinds of schemes, you'll find hundreds of Silicon Valley multimillionaires among those who were early or even mid-stage employees in companies like Google and Facebook. The increase in value of those companies was so staggering that if you were granted options at an early stage, their value multiplied by the hundreds.

But these kinds of schemes are not so common in New Zealand?

In New Zealand it has been less common, and done more on an adhoc basis, due both to tax considerations and securities law hurdles.

In New Zealand we have a few different types of schemes: we have options schemes, which are relatively simple to implement but where employees end up paying tax on the gains; but it's also possible to set up more complex share purchase schemes where the gains aren't always taxable.

Most jurisdictions outside of New Zealand, however, have capital gains taxes so there's no reason to swap between different kinds of schemes.

The impact of that in New Zealand is it's made the scene more complicated, because there's no standard way of doing it that people agree is appropriate from a tax perspective.

Until recently, our securities laws also made it hard for private companies to set up employee share schemes. However, from earlier this year, the Financial Markets Conduct Act introduced a significant new exemption that allows private companies to implement share schemes to incentivise employees, provided they're not issuing more than 10 per cent of their shares in a particular year.

So if you're going to set up a scheme, what are some of the things you need to consider?

You need to think about the price at which you're going to issue these shares or options, so you need to figure out what's the value of your company today.

You also want to use the scheme to retain people, so you have to design the rules so that people stay for a certain period of time before they're able to actually buy the shares - that's what's called 'vesting'.

Also, if people leave, say after three years, there's usually a period of time under which they have to exercise their rights. Generally you don't want lots of former employees out there who still have options to buy shares in the company.

If you're going to set up a scheme, you are best to work with a lawyer and accountant who can help you design a scheme that meets your objectives as well as helping ensure that your constitution and/or shareholders' agreements are suitable for use with employee shareholders. And you obviously need your accountant's input to make sure it's all done in a way that's appropriate from a tax perspective for you and your employees.

How many companies have these in place?

The considerations I'm talking about are really for private tech companies. In that little universe, while the old securities law barriers existed, I would talk to 10 to 20 companies each year that wanted to set up schemes, but I would guess less than half of these would go ahead due to the compliance difficulties involved. This has meant there is quite a bit of pent up demand for these schemes, and I expect the number being set up will increase three- or four-fold this year.

The economic benefit of greater employee share participation will take a lot longer to work through. It will often take several years for options or a share scheme to be worth something in the hands of the employee, and ultimately you're depending on the company being sold or listed to get liquidity that allows you to exercise your rights and sell your shares.

But what there will be with more of these share options and schemes being put in place is a greater number of employees feeling happier about working for New Zealand tech companies, because they're being treated more like people in Silicon Valley. That's essentially what many tech employees want - equity participation.

Simmonds Stewart has free online templates for tech companies, including documents relevant to employee share schemes: simmondsstewart.com.

A blog post by Andrew Simmonds also summarises the exemptions related to employee share schemes under the FMCA that came into effect on 1 April this year: simmondsstewart.com

Coming up in Small Business: Do you need a business plan? How do you go about putting one together and what impact can it have on your operation? If you've got an interesting experience with business planning to share, drop me a note: nzhsmallbusiness@gmail.com