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As the level of M&A activity increases in the financial services industry post Royal Commission, it’s time to put in place incentives so you don’t lose key employees.

Many business owners count on key employees being there to take over the reins. But often key employees leave to work for a competitor or start their own business.

When a key performer leaves your business it can significantly impact both you and the future of your business. As a result you may:

  • Lose income;
  • Incur additional or unbudgeted costs finding a replacement; and/or
  • Lose focus on your business while you find and train a new person.

You can stop key people from leaving with succession agreements

You can stop key people from leaving your business by giving them an incentive to stay. With a succession agreement you can lock key performers in without necessarily giving up equity or your business.

The upside can be significant, including:

  • Reducing the risk of key performers leaving;
  • Giving key performers security over their future; and
  • Allowing you to plan for your exit without any time or sale pressure.

How do you choose an appropriate succession agreement?

There are several different ways that you can structure a succession agreement. The choice you make depends on a range of factors. Before you decide on the right type of agreement you need to decide:

  • How the arrangement will be structured (having regard to tax for example);
  • What milestones each of you need to reach;
  • What benefits the employee will receive;
  • How the benefits will be valued; and
  • How the benefits will be paid for.

Once you have decided these issues you can choose the best type of agreement. There are three common ways to structure your succession arrangements.

1. Shadow or phantom equity

This involves giving key employees a cash incentive rather than equity. The cash incentive is calculated as if it were equity, so it may look like a dividend or payment for the sale of equity. The incentive payment is triggered and payable when specific predetermined events happen, like if the business achieves a set of KPIs or targets.

Shadow equity can be a good option if equity cannot be transferred now because of CGT or other tax issues.

A Shadow Equity Agreement is between the business owner and the key employee(s). It doesn’t generally require much ongoing administration.

2. Employee share schemes

Also called employee share purchase plans or employee equity schemes, an employee share scheme gives key employees the ability to become shareholders in the business. How they get that equity is up to you. You can:

  • Gift it to them;
  • Sell it to them at a discount; or
  • Sell it to them at market value. You can also help employees fund this through dividends or salary sacrifice, for example.

The type of equity that you offer employees can be in the same class as your equity or a different class. For example, you may choose to give employees a class of shares that doesn’t have voting rights so you can maintain control.

As securities are offered and issued under this arrangement, the documentation and ongoing administration will be more complex than for a Shadow Equity Agreement. Some of the legal documentation that may need to be arranged includes:

  • An Information Memorandum;
  • A Subscription Agreement;
  • Class rights if you create a new class of shares for the employee share scheme; and
  • The company’s Constitution and Shareholders Agreement may need to be amended.

3. Agreement to sell down

An agreement to sell down lets you sell your equity to your key employees. This gives you the opportunity to plan a complete exit without having to find another buyer. It’s also a good way to incentivise key performers now without diluting your equity holding.

The sell down could happen over several tranches linked to set milestones. For example, a certain amount may be transferred or sold to an employee each year over five years or be triggered upon meeting specific EBIT targets.

Like employee share schemes, you can decide how the sale is priced and funded. It could include:

  • A combination of free transfers and market price tranches;
  • Sale of equity at a discount; or
  • The use of dividends or salary sacrifice to fund the purchase.

This type of agreement will involve documentation and regulatory requirements including:

  • A Sale Agreement;
  • Changes to your company’s Shareholders Agreement;
  • Updates to your company register; and
  • Notifications to ASIC when each tranche is transferred.

Protect your business

These agreements allow you to protect your business from the impact of losing a business owner and can give key employees comfort that your business is protected. If your business has more than one partner, you should also put in place a Buy/Sell Agreement, backed by insurance. This agreement may also need to be amended to take into account the succession agreement that you have in place for your key employees.

If you need help deciding what’s the best way to incentivise your key employees, get in touch. We’d be happy to help.

Katie Johnston

March 2019

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