Employee share plans for start-ups – getting it right

Angela Bucher Director, People and Organisation, PwC Switzerland 24 Aug 2021

A well-thought-out employee share plan (long-term incentive plan, or LTI) can drive your business forwards, provided it’s aligned with your company’s needs. It can also avoid negative consequences for your start-up, your shareholders and your employees. So what do you need to keep in mind?

LTIs come in lots of different forms, including options, tokens and deferred cash plans. A well thought-out LTI can help a start-up attract talented people, gain their loyalty and motivate them. An LTI can also help you successfully implement your strategy, achieve the company’s goals and become more tax and cost-efficient. While the first challenge is getting the design of an LTI right, implementing it (e.g. drawing up the legal documentation) is just as important if you want to avoid any unwanted surprises. If a start-up pays attention to all aspects of its LTI, it protects itself from potential problems in the future. These include, for example, employees who make irreversible promises, leading to unpleasant (and often costly) problems.

To make sure your LTI adds value rather than just extra costs with no impact, we advise you to consider the following points:

What does a well-designed LTI look like?

Start-ups often look to best practice, but was does a well thought-out and practical LTI look like? There are many possibilities, and what works for another company might not be the right fit for you. It is important to start by setting the basic direction, i.e. decide between artificial participation in the form of cash and real participation in the form of shares:

Cash-based LTIs allow for greater flexibility, are easier to manage and protect your start-up’s capital structure. However, this type of LTI comes with certain risks for your company. Share-based LTIs strongly align the interests of employees with those of the company. In additional, private capital gains are tax-free in Switzerland and the accounting treatment for share-based LTIs can be more advantageous than for cash-based LTIs. On the other hand, share-based LTIs have an impact on the capital structure and entail a greater administrative burden.

Depending on whether you choose a cash-based or a share-based LTI, you then need to determine the structure, such as the specific instrument you will use, eligibility and forfeiture rules. For a share-based LTI it is also essential to define a share value for tax purposes. This is especially important to avoid negative surprises when selling shares (i.e. avoiding a share of the proceeds being classified as earned income).

Why are plan rules essential?

The plan rules and associated documents provide employees with information about the design of the LTI, but also protect the employer from risks. When implementing an LTI, it is recommended that you have the following documents:

  • Term sheet: this document sets out the LTI framework so that it can be discussed with the relevant stakeholders (shareholders, board members, etc.).
  • Plan rules: these form the contractual basis of the LTI and are absolutely essential to protect the company from risk; the rules must find the right balance between general and specific formulations, for example giving the company a suitable margin of discretion, while also ensuring sufficient legal certainty for those who enrol in the plan.
  • Tax ruling: this document provides clarity with regard to the tax treatment of the LTI and the corresponding employer obligations, in particular with regard to the tax-relevant value of the shares (tax-free private capital gains).
  • Shareholders’ agreement: for share-based LTIs, it is highly recommended that this agreement provides for long-term risk prevention and covers topics such as right of first refusal and tag-along/drag-along rights.
What else should be considered?

It is essential that you keep an eye on the big picture:

  • existing shareholders and founding members might be affected by the introduction of an LTI and you may also need to assess the possible impact on your wealth tax burden
  • monitoring of financial feasibility and cash flow
  • new and existing agreements need to be aligned (e.g. various shareholders’ agreements and valuation methods)
  • communication is key to ensuring stakeholders (i.e. shareholders and employees) are fully incentivised
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Long-term incentive plans (LTIs) for small and medium-sized enterprises (SMEs)

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Contact us

Angela Bucher

Angela Bucher

Director, People and Organisation, PwC Switzerland

Tel: +41 58 792 43 16