Retaining key staff – Incentive schemes

There are many models for retaining key staff. The model should be chosen based on what you wish to achieve with the scheme. This can range from simple cash bonuses (annual, KPI-based), share-based remuneration (e.g. options/warrants, or direct allocation of shares), or synthetic schemes, such as phantom shares.

About share-based or partnership-based schemes

Share-based or partnership-based schemes are a key tool for attracting, motivating and retaining key employees and management. These schemes give participants a right, but not an obligation, to purchase equity interests in the long term at a predetermined price and under agreed terms.

The right design requires clarification of allocation criteria, vesting and exercise conditions, handling in the event of resignation and exit, as well as interaction with the ownership structure, company law framework and tax implications. At the same time, the scheme may be subject to the Share Option Act, which, amongst other things, sets out requirements regarding the information the employee must receive.

It should also be noted here that there may be company law considerations to take into account. For example, it is not always desirable for all classes of capital in the company to be treated equally. This may relate to dividends or voting rights at general meetings. Pay particular attention to any amendments to the articles of association, changes to the register of members, and the risk of dilution for existing owners.

The authorisation of a capital increase or warrants requires a validly convened general meeting; alternatively, the board of directors may be granted a power of authorisation, to be incorporated into the articles of association, specifying the type, amount, expiry date and any waiver of pre-emptive rights. Multiple authorisations must be set out separately in the articles of association; issuance at a preferential price or a waiver of pre-emption rights requires the correct statutory framework, and in some cases unanimity amongst shareholders.

It is important to establish clear good leaver/bad leaver rules, performance criteria, vesting, change-of-control provisions and arrangements for maternity leave/sickness. Here, alignment must be ensured with the employment contract and any collective agreement provisions.

A brief overview of taxation: It can be particularly attractive to be taxed under Section 7 P of the Assessment Act. However, this means that, as a general rule, a maximum of 10% of annual salary may consist of share-based remuneration. If this is offered to 80% of employees on equal terms, the limit may be increased to 20%. For certain companies, this can be increased to up to 50% – but only if specific conditions are met. This allows taxation to be deferred until disposal and to be applied in accordance with the rules for share income. However, this also means that the company is not entitled to a tax deduction for the value of the grant. There must be a written agreement setting out key terms, including conditions for vesting/exercise, and there must not, for example, be a separate class of employee shares.

Points to bear in mind when purchasing a business

When acquiring a business with an existing warrant scheme, this should be reviewed with great care. As the scheme can affect the purchase price, dilution, transaction structure and the incentive structure following completion, there can be significant value in conducting thorough due diligence on this point.

In this context, you should consider the following:

• Start by obtaining a complete overview of all outstanding warrants, including holders, grant dates, exercise prices, remaining terms and total dilution.
• Map out vesting models, including any cliff periods and performance conditions, as well as leaver rules with associated repurchase rights, and assess specifically how departures are handled.
• Be aware of whether a change of control of the company triggers acceleration and any earn-outs.
• Clarify the practical exercise mechanisms, including, for example, whether cash payments are used, and whether there are lock-ups or obligations/rights to include shares on exit.
• Assess the interaction with shareholder and investor agreements: are warrant holders bound by the shareholder agreement via letters of intent, and how do pre-emption rights, co-sale rights, information rights and any veto rights come into play following the acquisition?
• Verify the corporate structure by reviewing the articles of association, general meeting resolutions and documentation for share issues, and check that all formal requirements have been met.
• Review the accounting treatment, including the impact on profit and dilution effects. These should be incorporated into the valuation and the pricing mechanisms of the purchase agreement.

Finally, due diligence should result in a concrete action plan setting out pricing and adjustment mechanisms, relevant covenants and closing conditions, as well as a plan for post-acquisition implementation. This must be based on a structured review of each individual incentive scheme and its risks.

Keller Law Firm can assist in designing the right incentive model for your business if you need to introduce schemes for your employees. We often work in close collaboration with the company’s management and its auditor. This ensures that all relevant factors are taken into account in the scheme.

With a well-thought-out model, the company can create a clear incentive structure, whilst ensuring that governance, valuation and reporting are handled transparently. We also assist with identifying risks through due diligence processes.