People influence the success and growth of businesses. Remuneration, as we learnt in last week’s article (“Disclosure of executive compensation in TZ”. The Citizen. June 1, 2019), should be sufficient to attract and retain directors – and I should add, employees – to run the business effectively while, of course, taking into account shareholders’ interests. It is postulated that employees and executives will perform better if they are greatly incentivised. Right?
Share option schemes are an explicit incentive by which some companies attract, motivate and retain talent, and ensure maximization of shareholder value. This article elucidates the concept and objectives of employee share options. In addition, the article clarifies, albeit briefly, how to set up an employee share option scheme and pinpoints the key documentation requirements as well as the duties and liabilities that arise in running such a scheme.
The term ‘share option’ is not defined in the Companies Act, 2002 of Tanzania, A 2002, but some annual financial statements confirm that companies interpret it to mean the right (not obligation) granted to an employee to acquire a specified number of shares in the company at future date and at a fixed price. This, however, does not apply to shares of Dar es Salaam Stock Exchange listed companies, whose prices are determined by fundamentals, which, at the basic level, refer to, inter alia, the direction of the market forces.
In Tanzania, share option schemes are not yet a serious issue as employees generally don’t anticipate to acquire dibs on shares in the companies they join. Nevertheless, there are startups and established companies in the country that are now looking to set up share option schemes as part of their compensation packages.
It is maintained that the schemes should play a greater role in aligning the interests of managerial employees and shareholders by turning managerial employees into owners and making them feel more connected to the company. Other objectives include remunerating employees in a tax efficient way and improving employee loyalty and reducing employee turnover, especially since it costs time and money for businesses to find, train and replace skilled employees who decide to throw in the towel.
But the objectives for launching share option schemes are debatable. Some shareholders argue that share option schemes can result in big payouts to employees for just average financial results, and that an individual employee should count on the collective output of his co-employees so as to receive a bonus.
So, how does a company go about setting up an employee share option scheme?
The initial step in selecting an appropriate share option scheme is to define the company’s motive and objective of launching such a scheme. Then, the company, as founder or settlor, together with the chosen trustees create a trust under the Trustees Incorporation Act, Cap 318 R.E. 2002. The trust created acquires and holds shares in the company, and the employees become the trust’s beneficiaries with rights to exercise their share options. The dividend payment made by the company to the trust from the company’s after-tax profit is paid out to the employees by the trust based on the option exercised by the individual employee.
In designing a share option scheme, it’s important to consider whether (and when) the shares can revert back to the ownership of the issuing company, the eligibility criteria for joining the trust, and the conditions for trust fund distribution. Key documentation requirements for setting up a share option scheme include board resolution sanctioning the launch of such a scheme, trust deed and applicable rules, and share options certificates for employees.
Certain legal duties arise when managing a trust as a vehicle for an employee share option scheme. These duties include a duty of loyalty, a duty of prudence, and other duties, such as, filing returns of the undertakings of the trust to the Administrator General upon payment of prescribed fees and filing tax returns and paying due taxes to the Tanzania Revenue Authority.
Next Saturday, we will be exploring the Tanzanian income tax implications of employee share option schemes.