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Forms of share pay – a short introduction

Here you get a brief introduction to the most common forms of share pay. You will find even more details about the different variants in separate articles about the instrument types.

Options: Risk-free incentive – especially in upturns

Options are a right, but not an obligation, to be able to subscribe for or buy shares in a company. Options usually have an vesting period, as well as an expiration date. The employee must exercise the option in the period between the vesting date and the expiration date. The option also has an exercise price (also often called a redemption price, “strike” in English), which is a pre-agreed price for which the shares can be purchased. It is usually a condition that the employee works in the company from the time the option is granted until the time of exercise. The employee can exercise this right from the time of vesting until the options expire.

When the share is to be exercised, it is most common for the employee to receive one share per share. option redeemed – this is typically done by the company issuing new shares (the company can also choose to use shares from its own portfolio or purchase shares specifically for this purpose). In some cases, participants may also receive a settlement from the company on the difference between the exercise price and the market price at the time of exercise. Such a settlement requires that the market price can be determined relatively objectively, and therefore works best in companies that have a liquid market for trading (typically companies listed on a form of stock exchange). Otherwise, it should be agreed in advance how the value of the share will be confirmed when the time comes.

For tax purposes in Norway, as a general rule, the entire difference between the exercise price and the market value (ie the gain) is to be regarded as salary, and is to be taxed as salary. Processes are underway that are examining the possibility of changing the tax rules for share options for Norwegian start-up companies, and some tax benefits were introduced in 2018. It is worth mentioning that the changes are very few – and also have little significance here due to scope.

The employer must thus pay employer’s contribution on this gain. The company will also receive a tax deduction in the same way as with a salary, provided that the shares have been bought into the market or shares from its own holding have been used. From the moment the share is purchased (the ownership of the share has been transferred), the value development is regarded as capital income at current rates.

In 2018, three quarters of the companies listed on the Oslo Stock Exchange used the Main Index’s share salary as part of the financial compensation. Options are the most popular instrument with about 50 percent against other instruments. More than 90 percent of the options apply to shares, rather than cash or synthetic.

Summary of benefits of options:

  • No risk for participant.
  • No taxation for participants before the option is used.
  • No employer’s contribution before any gain on the options.
  • No actual dilution for shareholders unless the company value increases during the period (provided that the redemption price corresponds to the market price at the time of allotment).
  • Binding effect on key employees and perceived value in times when the share price rises and remains stable.
  • Higher “leverage” than for ordinary shares as the participant will have more options (due to lower cost and dilution per instrument).

Summary of disadvantages with options:

  • Gains on the option are taxed on wages, in addition the company is obliged to pay employer’s tax on this.
  • No direct “skin in the game” can be considered negative for the company.
  • Low binding effect and perceived value if the share price declines over time.

Read more about Options

2. RSU (Promise of Free Shares): Hold on to key employees in good and bad times

A Restricted Share Unit (RSU) can be seen as an option with a redemption price of zero (possibly only the nominal value of the share), which means that the right to receive the shares is granted upon entering into an agreement. However, the shares cannot be disposed of until they are transferred to the employee on an agreed date. This means that the RSU has all the same elements as an option, but that where the option loses its incentivizing effect in a weak market, the RSU will maintain its motivating effect because it remains «in the money».

Summary of benefits of RSUs:

  • No risk for participant.
  • No tax before the shares are transferred.
  • Binding effect and perceived value in both ups and downs.
  • Zero investment in advance for company and employee.

Summary of disadvantages with RSUs:

  • Gains on the RSU (value of the share at the time of transfer) are taxed as salary.
  • Lower gearing an options due to lower quantity at the same “cost”

Read more about Restricted Share Units

3. RSA: Divide the risk by lower taxes

Restricted Share Award Program (RSA) is shares allotted and transferred to the employee “today”. The shares provide voting rights and dividends as ordinary shares. However, the transfer of the shares is usually followed by a period in which the shares cannot be sold, and the company can retain the right to buy the shares back at acquisition value, if the employee leaves the company. This results in a taxable value on the grant date. At the same time, the restriction leads to a reduction in the “actual value” of the shares, and thus gives a lower taxable value – something we will return to in a later article.

Summary

Benefits:

  • Binding effect and perceived value even if the share price falls.
  • Capital tax on gains resulting from a share price increase from the time you received the share.
  • Give a “tax rebate” as a result of the lock-in period.
  • No downside for the participant given that the share is given away free of charge to the participant.

Disadvantages:

  • High tax value when allocating
  • Lower gearing than options due to lower quantity
  • Can be considered a “free lunch” from the shareholders’ point of view – no direct risk for the participant.

Read more about Restricted Share Awards

4. Purchase and savings programs: Invest in your own company – with a discount

Purchase or savings programs for employees are most often used to allow a larger proportion of employees to take part in ownership and value development in the company. Smaller volumes and values ​​are usually included (worth noting that it can also be used for smaller leading groups with larger volumes).

These types of programs are often structured with a discount and a lock-in period where the employee cannot sell the shares. The programs can be structured as one-off investments (preferably also with payday loans where the money is deducted from salary afterwards), or savings programs where employees, for example, are deducted from salary monthly and the money accumulates before buying shares for savings once a quarter. In other words, the main difference between a purchase and a savings program is whether you save in advance of a purchase or not. Here, the concepts are not clearly defined nor are they so important.

It is common to offer these programs at set time intervals. The purchase programs require a lot of capital in advance from the employee and are therefore, as mentioned above, often combined with a loan from the company (as a general rule, such a loan must be offered to all employees – see more details by clicking on the link below). It can also be combined with matching / bonus shares or performance shares for extra motivating and / or targeted effect.

Read more about purchase and savings programs

5. Synthetic instruments

All of the above instruments can be made synthetic. Synthetic stocks, also called phantom stocks and shadow stocks, are “imaginary stocks” that do not provide actual ownership in a company. The employee’s gain depends on the development of the share, but the participant never receives actual shares. Such models require that there are clear agreements on how the calculation of values ​​is to be set if one does not have a clearly defined share price (as for listed companies). With the exception of actual ownership, voting rights and dividends (this can be agreed otherwise), synthetic models will have the same advantages and disadvantages for the employee as if you settle in shares.

Less than ten percent of Norwegian option agreements are synthetic. The reason why someone still chooses to use such a solution may be, for example, to prevent dilution of the share, and difficulties with ownership due to account setup (especially related to some specific countries). For listed companies, especially the multinationals, it can in some cases be demanding to hold shares and adapt to different cultures and laws for ownership. It is worth noting that synthetic schemes can be very “money-heavy” if stock prices rise – given that hedging instruments are not included in the program. In addition, accounting for synthetic instruments can be more demanding and lead to less stable costs.

Compensation through synthetic shares is also taxed as a general wage income. Here, there may also be challenges related to whether the instrument should be taxed on accrual or when the money is actually paid out. Here, each individual case must be carefully considered to avoid unwanted effects.

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