Incentive plans - Event Management Tool for Matchmaking ... · PDF fileIncentive plans Remo...

10/18/2012

1

9th CEO Day, October 24, 2012 - Bern

Incentive plans

Remo Schmid Joop Smits Partner Senior manager

www.pwc.com

PwC

Contents

• Introduction

− Total Compensation

− Employee Participation

− Trends

• Case study: Welldone Inc Stock option plan

• Additional examples

− Foundation

− Investor

− New Hires

− Sale of Shares

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Elements of Total Compensation: Best Practice Considerations

• Participation in the long-term sustainable value creation (prospective view)

• Enforcement of corporate culture and business strategy

• Alignment of interests of shareholders and management through ownership

Base salary

Bonus

LTI

• Important remuneration element (long-term wealth accumulation)

• Pressure on funding of liabilities (asset performance and ageing of society)

• Social security planning and compliance

• Fixed compensation element, representing market value of function

• Functional grading system serving as basis for total compensation system

• Stronger focus on base salary

• Short-term retrospective performance measurement (quantitative and qualitative goals)

• Risk adjustment and use of non-financial metrics (including discretion)

• More long-term oriented (deferred mechanism and bonus bank)

Pensions & Social Security Fringe

Benefits • Tailored and tax efficient offering

• Cost control Ow

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Introduction

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Salary Elements and their Impact

LTI (Equity)

Bonus

Variable

Direct ‘Cash Out’

for the company

Prospective, long-term

Retrospective,

short-term business

and individual goals

Introduction

Base salary

Bonus

LTI

Pensions & Social Security

Fringe Benefits

Fix

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Stages in a Company‘s Development

Start-Up

Base

Equity (e.g.

Options)

Base

Bonus

Equity (e.g.

Options)

Base

Bonus

Equity (e.g.

Shares)

Base

Bonus

Equity (e.g.

Shares)

Recovery Growth Consolidation

Introduction

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Specific Design

“IPO” Participation

“Pre-IPO” Participation

“Ongoing” Participation

Shareholders

Company Participants

Equity Based Compensation

Start-up

Introduction

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Eligible Employees

Eligible employees

Equity-Based Compensation

Middle Management

Employees

Top Mgmt

Introduction

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Basic Equity-Based Compensation Models (Overview) Sorted by Underlying (Real vs. Phantom)

Introduction

Phantom Plans

Phantom Shares

Phantom Options

Bonusbank Models

.......

Real Equity Participation

Option Plans (tradable / non-

tradable)

Share Purchase Plans

Leveraged Share Plans

(shares plus options)

Matching Share Plans

Restricted / Performance

Share Units (RSUs / PSUs)

.......

LTIP

(Equity Based

Compensation)

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Market Trends According to the PwC Global Equity Incentive Survey 2011

Introduction

9

0%

5%

10%

15%

20%

25%

30%

35%

40%

2011 2009 2011 2009 2011 2009 2011 2009 2011 2009 2011 2009

Options RS RSU Stk Settled SAR Cash Settled SAR Phantom Stock

Type of Equity Offered

Market-based Performance-based

PwC

Contents

• Introduction



− Trends



− Foundation

− Investor

− New Hires

− Sale of Shares

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Our ESOP* methodology will guide our work

Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess Understand objectives, conditions and requirements

Design Agree term

sheet

Define and test

plan features

under different

scenarios

Construct Agree on details

KPI’s, valuation

method

Plan regulations,

share holder

agreement, tax

rulings

Implement International due diligence, administration, communication

Operate and Review Regular measurement, accounting and communication

Assess Agree on main features Baseline

Initiate Project

• Agree on scope

• Project planning business & HR planning

• Stakeholder management

• Set up project team

Preparation

• Identify main objectives, conditions and requirements

• Assess existing compensation structure

Approach and methodology

Rough design

• Real equity or phantom

• ‘Soft landing / hard landing’

• Define target group

• Define KPI’s (one for all or differentiation around functions / levels / divisions)

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* Employee Share Ownership Plan

PwC

Our ESOP methodology will guide our work

Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess

Understand objectives, conditions and requirements

Design Agree term sheet Define and test plan features under different scenarios

Construct Agree on KPI’s,

valuation method

Build plan

regulations, share

holder agreement

and tax rulings




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Welldone Inc.

Welldone Inc. is a privately owned technology startup company, offering global virtual networksand smart technologies to customers requiring cost effective solutions.

Welldone was set up in 2009 by skilled professionals with entrepreneur's spirit who share a vision for pioneering technologies.

The company has grown to 15 employees and with will shortly start international sales.

Welldone decided to create a long term incentive (LTI) for its management team, key employees and international agents in order to align the people’ interest with the company’s long term business strategy.

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Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term sheet Define and test plan features under different scenarios


valuation method

Build plan

regulations, share

holder agreement

and tax rulings


Operate and Review Regular measurement and communication

Term Sheet




Financial modeling

• Scenario forecasting considering different economic and performance developments

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Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term

sheet

Define and test

plan features

under different

scenarios


valuation method

Build plan

regulations, share

holder agreement

and tax rulings


Operate and Review Regular measurement and communication


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Welldone Inc

After assessing different alternatives, it was concluded that a real participation should be offered and not a phantom scheme. Considering various possibilities an option plan meets the requirements best, especially because:

• no up-front investment is needed

• options provide an incentive to increase the value

• options can lapse in case of termination (retention)

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Main plan features for Welldone Inc.

Option The right to purchase a Welldone inc share at a fixed price in the future

Grant Free of charge

Option term The options have a term of 10 years as from the date of grant

Exercise price “at the money”

Vesting period The options vest after a period of two years

(cliff vesting and no performance conditions)

Tax treatment Taxation of the options at the date of exercise and to avoid any up-front taxes (at grant) >> a tax ruling will have to be approved)

Valuation EBITDA X “industry multiple”

Blocking The shares are subject to a blocking period of 3 years after exercise of the options

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Term sheet 1/2

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Main plan features for Welldone Inc.

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Term sheet 2/2

Option term = 10 years

Grant note

Vesting 2 years Options can be exercised

during the option term Option Exercise Note)

Lapse

Option Agreement

Procedure and plan notes

Eligible Persons

Frequency and number of grants

Repurchase rights / obligations

Drag along / tag along

Voting and dividend rights

Governance and management of the company

Future changes of the share capital and pre-emptive right

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• Options used to be taxed at grant:

change of legislation / practice >> tax at exercise

• Shares are generally taxed at grant / share allocation, irrespective of additional restrictions

• In case of blocking periods, a tax discount on the fair market value of the shares applies:

Tax treatment: Swiss Income Tax Treatment 1/2

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Timing Discount Taxable value

1 year 5.660% 94.340%

2 years 11.000% 89.000%

3 years 16.038% 83.962%

4 years 20.791% 79.209%

5 years 25.274% 74.726%

6 years 29.504% 70.496%

7 years 33.494% 66.506%

8 years 37.259% 62.741%

9 years 40.810% 59.190%

10 years 44.161% 55.839%

PwC

Market Value

of the Share

Tax Discount*

Tax Value

of the Share

Tax Discount

Purchase (exercise)

Price paid by

employee

Taxable Benefit

Gross Employment Income

* for blocking period

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Tax treatment: Swiss Income Tax Treatment 2/2

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Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term

sheet

Define and test

plan features

under different

scenarios

Construct Agree on KPI’s, valuation method Build plan regulations, share holder agreement and tax rulings



KPI definition




Plan documents

• Share holders agreement

• Grant / exercise notes etc.

• LTI plan regulations

• Tax rulings

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Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term

sheet

Define and test

plan features

under different

scenarios


valuation method

Build plan

regulations, share

holder agreement

and tax rulings




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Welldone Inc.

Plan rules

Valuation method

Notes

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Welldone Inc: Stock option plan rules

• Legal document with detailed description of features as agreed in term Sheet

• Ensure alignment with Shareholders agreement

• Additional features, such as:

Restrictions on transfer of options

Change of control

Administrator

Valuation of the underlying share

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Considerations for valuation:

• Does the nominal value equal the fair value of the company? If not, taxes may arise upon foundation.

• Shares need to be objectively valued for tax purposes.

• The valuation method needs to be the same at purchase and at sale of the shares in order to avoid tax issues. Current practice is getting tightened.

PwC


Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term

sheet

Define and test

plan features

under different

scenarios




Due diligence

• Legislation / approvals

• Employee / employer taxation

• Social security

• Salary withholding requirements

• Documentation and required approvals


Administration

• Identify and store equity data for participants;

• Allocation, vesting , de-blocking, exercise of option, sale of share

• International mobility

• Payroll and reporting

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Communication

• Fully leveraging the ‘perceived value’ of the LTI

• Explain plan features and rules

• Demonstrate upside potential and downside risks

• Letters, presentations, meetings, etc..

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Programme Delivery

Project Management

Dri

vin

g C

ha

ng

e

Assess


Design Agree term

sheet

Define and test

plan features

under different

scenarios





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Accounting Repurchase obligation, if any, for the company generally results in a liability, to be analyzed in detail

Recharging plan costs (recharge agreement) for corporate tax purposes

PwC

Contents

• Introduction



− Trends



− Foundation

− Investor

− New Hires

− Sale of Shares

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• Welldone Inc. is founded by two persons

• Share capital 100k: 1‘000 shares per nominal 100

• Cash foundation: 50k per founder, i.e. each 500 shares

Additional example I: Foundation a) Assumptions

Questions

1. Which Swiss individual tax treatment applies to the two founders with respect

to the foundation?

2. What are the potential issues to be considered for the newly founded

company?

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• Purchase of shares is not based on an employment relationship, but is an investment

• Purchase price = Fair market value of the share

Additional example I: Foundation b) Proposed Solution for First Question

Results

No Swiss income taxation, as the purchase of shares is an investment at fair

market value.

Shares held are subject to Swiss net wealth taxation.

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Additional example I: Foundation c) Potential Issues / Considerations (Inputs to Second Question)

Issue Consideration

Valuation Does the nominal value equal the fair value of the company? If not, taxes may arise upon foundation.

Shares need to be objectively valued for tax purposes, and the valuation method needs to be the same at purchase and at sale of the shares in order to avoid tax issues. Current practice is getting tightened (e.g. Zurich, see slide 44).

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• Company is growing; needs funds

• Conditional capital for future employee participations is approved

• Investor gets in

• Capital increase

• Value of a share on the occasion of this financing round: 180

• At the same time, the founders sell each 10% of their shares (i.e. each 50 shares) to the management at a price of 150 per share

• These shares sold are subject to a disposal restriction (pre-emption right for the founders) and re-purchase rights for the company within 3 years as from selling

Additional example II: Investor – Part I: Shares a) Assumptions

Questions

1. Which Swiss individual tax treatment applies to the managers with respect to the share purchase?

2. What are the potential issues to be considered for the company?

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• Shares are generally taxed at grant / share allocation, irrespective of additional restrictions

• In case of blocking periods, a tax discount on the fair market value of the shares applies:

Share Purchase Plans in General: Facts and Figures Swiss Income Tax Treatment 1/2

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Timing Discount Taxable value

1 year 5.660% 94.340%

2 years 11.000% 89.000%

3 years 16.038% 83.962%

4 years 20.791% 79.209%

5 years 25.274% 74.726%

6 years 29.504% 70.496%

7 years 33.494% 66.506%

8 years 37.259% 62.741%

9 years 40.810% 59.190%

10 years 44.161% 55.839%

PwC

Share Purchase Plans in General: Facts and Figures Swiss Income Tax Treatment 2/2

Market

Value

of the Share

Tax

Discount*

Tax Value

of the Share

Tax Discount

Purchase

Price paid by

employee

Taxable

Benefit

Gross Employment Income

* for blocking period

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Share purchase by the management

Share value: 180 (financing round)

Price paid: 150

Taxable benefit: 30

Chapter 2: Investor – Part I: Shares b) Proposed Solution

Results

The amount of 30 per share (purchase price reduction/discount) represents a taxable benefit and is subject to Swiss income taxation and Swiss social security charges at purchase.

The shares held are subject to Swiss net wealth taxation.

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Chapter 2: Investor – Part I: Shares c) Potential Issues

Issue Consideration

General

In principle: The same value issues as mentioned for the founders, see slide 13. Additional issues and topics mentioned below.

Shareholder structure Number of shareholders will be growing, loss in control.

Growth and „Exit“ Strategy

Shareholders‘ Agreement recommended. Topics to be set: Repurchase rights/obligations, drag along / tag along, etc.

Accounting Repurchase obligation, if any, for the company generally results in a liability, to be analyzed in detail.

Legal nature of transaction

Share purchase between shareholders or based on employment relationship?

Social security costs Company has to pay social security on taxable benefit.

Case Study: 4 Start-Up Phases

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Chapter 2: Investor – Part I: Shares c) Potential Issues

Issue Consideration

Particularly for Start-Ups

Selling/disposal restrictions

Influence on tax value of the shares? The selling/disposal restrictions are not blocking periods in the sense of the Federal Circular Letter, therefore, no tax discount.

Share price Share price used for financing round relevant for tax purposes?


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Besides, the management is granted 800 options subject to the following conditions:

• Exercise price 200

• Term 10 years

• Blocked for 3 years (i.e. only exercisable after 3 years)

• No forfeiture in case of termination of employment (i.e. no vesting conditions)

• Option value pursuant to valuation model = 40 per option

Chapter 2: Investor – Part II: Options a) Assumptions

Questions

1. Which income tax impacts has the option grant for the management?

2. What are the potential issues to be considered for the company?


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Most cantons (mainly German speaking area):

Options in General: Facts and Figures Swiss Income Tax Treatment

Vesting Conditions?

yes no

Taxable moment: Exercise Taxable value: Exercise gain (Difference between exercise price and underlying share value at exercise)

Taxable moment: Grant of the option (if valuable)

Taxable value: Market value of the option at grant

Exemption Zurich: Risk of taxation at vesting, depending on actual design (to be checked!)

New federal law regarding consistent approach of taxation at exercise. Effective as of January 1st 2013

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Options granted to the management

• No vesting conditions Legal ownership at grant

• Blocking period can be taken into account for the tax value of the options

Chapter 2: Investor – Part II: Options b) Proposed Solution

Results

Income taxation at grant on the tax value of the options (blocking period taken into account).

Options held are subject to Swiss net wealth taxation

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Chapter 2: Investor – Part II: Options b) Proposed Solution – Illustrative Option Valuation

Market value Tax value

Share value at grant: 180 180

Blocking period: 3 Years

Discounted share value (blocking): 151.13

Exercise price: 200 200

Riskless interest rate: 3% 3%

Volatility p.a.: 25% 25%

Option term: 10 Years 10 Years

Dividend yield: 2.5%

Dividend yield (on discounted share value): 2.98%

Option value: 40 24

(Taxable at grant)

In % of share value 22% 13%

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Chapter 2: Investor – Part II: Options c) Potential Issues

Issue Consideration

In General

Option design Taxable moment and amount: Tax ruling recommended.

Hedging Company has to provide shares in the future.

Social security costs Company has to pay social security on taxable benefit.

Accounting Treatment To be carefully analyzed in detail.

Particularly for Start-Ups

Valuation of the option at grant

Gathering of data (e.g. share price, volatility, etc.). If options cannot be objectively valued at grant, they are taxed at exercise. Ruling recommended.

Plus: Upon option exercise, the participants are shareholders; thus, same issues like for share participation plans, see slides 29 and 44.

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• Company is growing

• Specialists are needed

• The company pays lower base salaries, but offers options as an additional incentive. The total compensation will be as follows:

Base salary p.a. CHF 80‘000

400 Options* CHF 20‘000

(value at grant = 50 each)

Total value compensation CHF100‘000

Chapter 3: New Hires a) Assumptions 1/2

* Design details see next slide

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Parameters of the options granted:

Chapter 3: New Hires a) Assumptions 2/2

Option term 10 years

Vesting period 3 years

Truncation After the vesting period: Exercise within 12 months in case of termination of employment

Share value at grant of option 250

Exercise price 250 („at the money“)

Fair market value of the option at grant

50 per option (according to valuation)

Questions

Which Swiss individual tax treatment applies to this employee?

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Chapter 3: New Hires b) Proposed Solution

Results

Salary of CHF 80‘000 is subject to Swiss income taxation and social security charges at the date of payment.

Options with a design as mentioned in this example are subject to Swiss income taxation at exercise, i.e. no taxation at grant.

For Swiss net wealth tax purposes, the options have to be listed in the individual tax return (asset statement) with a “pro memoria” value until exercise.

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Chapter 3: New Hires c) Potential Issues

Issue Consideration

Option Design Regarding taxable moment and amount please refer to slide 38.

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Chapter 4: Sale of Shares a) Assumptions

• Founders decide to sell the company (trade sale)

• The value per share is 1000

• Employees can sell their shares as well (including the shares underlying the options which are exercised immediately)

Questions

1. Which income tax impacts has the sale of shares for the managers?

2. What are the potential issues to be considered for the managers?

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Share Purchase Plans in General: Zurich Information Letter, October 21st 2009

Sale of employee shares held in private assets

Positive difference between the sales proceeds and the calculated value of the employee shares at the time of sale (not using the same valuation method as at allocation) will constitute taxable income where:

• Employee shares are sold less than five years from the allocation date

• Employee shares are repurchased by the employer

• Continue to use an accepted valuation formula, despite the availability of a market value

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Chapter 4: Sale of Shares b) Proposed Solution

Results

In general, private capital gains are tax-free in Switzerland

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Chapter 4: Sale of Shares c) Potential Issues

Issue Consideration

Sales price Part of the sales proceeds might be taxable as income (salary) and does not qualify as tax-free private capital gain in Switzerland

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Questions?

47

Thank you!

© 2010 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to the network

of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and

independent legal entity.

Remo Schmid, Partner PwC Birchstrasse 160 Postfach, 8050 Zürich +41 58 792 99 04 [email protected]

Joop Smits, Senior manager PwC Avenue Giuseppe-Motta 50 CH-1211 Genève +41 58 792 91 64 [email protected]

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