In recent years, companies have been looking at ways to align the goals of their employees and owners. Traditionally the motivation of these two groups of individuals could be quite different. The owners’ goal was, and is, to grow the business, both from a financial standpoint and other – this is because they know that their personal income is not finite, and it is not capped to ‘just’ their salary. As the business becomes more profitable, they too increase their wealth through company distributions.

On the other hand, employees who receive a salary know that, to a certain extent, their income is finite and not matter how much the company grows and how well it performs, their personal income is limited by the employment contract they have in hand.

Bonuses and other similar incentives start to narrow the gap between the two driving forces mentioned above, however, this is not always enough. Stock options are being used more frequently to ensure that it is not just the shareholders who benefit from the financial growth of the company, but this is also beneficial to several employees who would also have a share in the company.

Stock options are seen as an important motivating tool, not simply because of the financial element behind them, but because employees become shareholders and own part of the business they are working for. This provides a sense of pride, loyalty, and ownership, which are key to ensure a highly motivated workforce.

We are also seeing the use of what is known as ‘phantom’ stock options, whereby the employee receives the same benefits he/she would receive had he/she been a shareholder, without actually owning any stock. The dividend payable to such employees is typically in the form of a cash bonus, equivalent to the percentage of phantom stock held.

Both the stock options and the phantom shares are commonly used by start-up companies as they wouldn’t yet have sufficient cash to lure talent and employees, they compensate for this by giving up equity to their team.

As with every business transaction, tax also plays an important role in stock options. In most countries, the granting of the option to employees is not a taxable transaction. It is the exercise of the option which becomes taxable. In most cases, the employees are provided an option to acquire the shares for free, or at a fixed price which is lower than the market price, within a definite time frame. Complications do arise when valuing the shares of non-listed companies, to establish the gain made by the employee when exercising their option.

A number of countries incentives these types of options through tax benefits, typically at employee level. Many countries opt for a reduced rate of tax when taxing the employee on the difference between the strike price and the market price. Other countries, including Rwanda, provide other benefits, such as the exemption from withholding tax and Capital Gains Tax on dividends received from shares acquired through a share option programme.

We will continue to see a mix of share options provided to employees and tax benefits linked with such options, as these schemes provide a win-win situation in an employer – employee relationship. The stock option may take various forms and is often linked to the achievement of certain milestones – what is important is that the benefits being provided are aligned with the company’s long term goals.

November 2021

The writer is a co-founding partner of Seed, an internationally focused research-driven advisory firm based out of Europe (Malta) and the Middle East.

www.seedconsultancy.com | nicky@seedconsultancy.com