Skills shortages: Could employee share schemes be the answer?

This article was current at the time of publication.

In a tight market for recruitment and retention, employee share ownership plans (ESOPs) are gaining in popularity among accountancy firms as tools to secure succession and lock in talent.

Faced with an ageing workforce, share schemes can also provide an exit strategy for existing owners.

A tale of two firms

JSA Audit established its New Zealand equity participation plan six months ago and it has already seen benefits.

The firm added two shareholders to the original three, including a long-sought practice manager.

“The attributes we wanted for this role were [someone in their] early 30s, someone from a bigger firm who wanted to be an equity partner,” says Mark Bezuidenhout CPA.

“You have to bear in mind that people in their late 20s or early 30s don’t have much spare cash. We wanted to make it as easy as possible [to buy in], while ensuring they have some skin in the game.”

The buy-in price was based on a fees-based valuation multiple, with half payment up front and half taken from the dividend the firm generates.

The original owners will probably always be shareholders, he says.

“You need to be there for continuity, especially with newer clients.”

Bezuidenhout has seen other schemes run into trouble because “once someone’s a shareholder, they think they know more than they do. You have to show them how to socialise with clients and talk to them at a different level, the level of a director and shareholder rather than [as] an employee.”

He and original owner Paul Leighton CPA think of their scheme as “the Socialist Republic of JSA.” The aim is to have all shareholders hold the same number of shares.

However, once a shareholder leaves the company they will be paid only a dividend, not a salary.

Bezuidenhout and Leighton’s advice to existing partners taking on new partners and shareholders is “don’t be too greedy. If it’s done right, they will make money for you”.

Auckland firm Gilligan Sheppard’s scheme has added 10 shareholders to the main four partners.

Partner Bruce Sheppard CPA says the scheme ensures succession, but its most important aim is “shared values and a sense of belonging”.

The buy-in formula is five times EBITDA plus cash, minus debt, discounted by 15 per cent to reflect the fact shareholders can only sell shares back to the firm.

Employees must have worked for the company for at least two years. Typically, about two-thirds of employees will be eligible, of whom half will take up the offer, assisted by an option to invest up to three times their annual bonus.

Sheppard says companies need to recognise that it’s hard to convince younger employees to buy in.

“Their destiny is fluid, and they probably see their career progress as moving from one firm to another. We invite our people to belong, but a bird sings best when the cage door is open.”

Which ESOP is right for your firm?

ESOPs can take many forms – it’s a question of finding the right one for your business.

As Fiona MacKinnon, a partner at law firm Kindrik Partners, says – “the big question is, what are you trying to achieve?”

MacKinnon divides the issues into three “umbrellas” – regulatory, commercial and governance.

Regulatory issues include securities legislation, for example, whether a scheme is an offer of securities under the Financial Markets Conduct Act (FMCA). 

If it is, some exclusions for share issues to employees are available under the act, but limited disclosure requirements – providing shareholders with annual reports and full-year financial statements – still apply.

“Companies have to understand these and decide whether they’re comfortable with them. For most, it’s not an issue,” says MacKinnon.

Another potential obstacle is a cap on issues of new shares at 10 per cent on a rolling 12-month basis.

“Some companies prefer to issue non-voting shares and keep the votes for the original shareholders. That can make it difficult to negotiate the 10 per cent cap,” MacKinnon says.

Taking tax into account

Tax is an important driver of structuring ESOPs. 

“There are pros and cons,” MacKinnon says.

“There can be material consequences of, for example, the decision whether to charge for shares up-front, or to provide loans to assist purchase.”

A key governance consideration is whether a firm needs a constitution.

“Rules have to be very well thought through and documented,” says MacKinnon. “It’s very difficult to ‘reverse-engineer’ a desired outcome to a situation that has arisen outside the rules.”

Firms should consider where the shares might end up in the event of a merger, amalgamation or outright sale, the death or retirement of a shareholder, or an employee leaving the company.

Rules might include restrictions on share transfers, pre-emptive purchase rights, and drag-along rights.

“If some shareholders want to merge or amalgamate or just sell, how and when and at what price?” asks MacKinnon.

“You don’t want holders of 1 per cent or 2 per cent to be able to veto the price, or the whole transaction.”

Another structure consideration is whether there should be a nominee company between the incomers and the company itself.

This can provide administrative convenience, especially where employee shareholders want exposure to the economic performance of the company, but don’t want governance or commercial decision-making responsibility.

MacKinnon says initial discussions around establishing an ESOP can be a helpful way of sounding out key team members on where they see themselves and what’s more important to them – economic benefits or control rights.

“Having a conversation that makes it clear someone’s a valued member of the team, who you’re keen to retain long term, is valuable in itself.”