Question

I recall reading a column that you wrote a couple of years ago about putting a structure in place so that younger employees can buy shares in a company. I foolishly did not cut it out so forgive me for asking a similar question again.

I’m getting to that stage where I want to become less involved in my company.  I want to enable a couple of trusted employees to get a share in my business.  My thinking is that if the business is well run, I will receive a sustainable income from the business when I retire.  My employees will become shareholders and have a vested interest in making the business succeed over the long term. How do I go about doing this?

Answer

The structure that you are talking about it’s called a preferred compensation plan. It is essentially a contract between the company an employee that is linked to an investment plan.

The way it works is that you identify those key employees that you would like to retain and become shareholders.

You draw up an agreement with the employee where you agree to increase his or her salary by an agreed amount.  This would be invested for a period.  At the end of the period, if certain agree milestones are met, the employee would receive the proceeds on an agreed basis.  This could be in cash, or in funds to buy a shareholding in the business or a combination of cash and shares.

You would increase your employee’s salary by the premium for the investment plus any tax that the addition of the premium to his or her salary would add.  It is important that the employee remain in a cashflow neutral situation. 

The employee would take out the investment policy and cede it to the employer as a security cession to fulfil his or her obligations to work at a satisfactory level for a particular period like 5 years.

At the end of the period, the employer cancels the security cession and the employee will have the proceeds to buy a shareholding in the business.

For example, if you would like a key employee to have R1m in 5 years’ time to buy a share in your business, you would increase his or her salary so that they would have an after tax amount of R12 0000 a month to invest.  This should increase by 10% a year.  If the investment returned 8% a year, the investment would be worth R1m after 5 years.

This is a great way for a business owner to:

• Extract capital from the business
• Attract and retain competent staff
• Improve BEE scores
• Structure the business to continue once you retire