While loan-funded share plans remain popular in unlisted companies, they continue to disappear across ASX-listed companies – and for no good reason.

A recent article in the AFR described how a loan-funded share plan has motivated management to drive growth in the share price of a $4.5bn market cap company. Shareholders and management are enjoying a 49% increase in the share price over the last 6 months.

The company’s AGM saw around 90% of votes in favour of the remuneration report and the director equity grant resolutions, notwithstanding ISS’ recommendation against the loan-funded share plan. Importantly, significant investors were loudly supportive of the structure and its alignment with their interests.

See a news media report HERE.

There are good reasons for companies – listed and unlisted – to adopt a loan-funded share plan for the LTI frameworks.

Loan-funded shares are used as long-term incentives because:

• Employees’ interests are aligned with shareholders.
• Employees own shares immediately and have dividend and voting rights.
• Share price appreciation is immediately apparent.
• The loan liability can be reduced with the after-tax value of dividends.
• There is no FBT liability for the employer.
• Like options, there is no downside for the employee, but they are motivated to get share price and/or dividend growth.

The setup is relatively straightforward. The company grants an interest-free, limited recourse loan to the employee for the sole purpose of acquiring shares at their market value.

The shares are under a holding lock for the term of the performance and vesting period. They may be subject to service conditions or performance conditions or a combination of both.

The balance repayable on the loan is the lesser of the value of the shares and the loan balance at the repayment date:

• If the share price is greater than the loan balance, the employee enjoys the share price appreciation.
• If the share price is lower than the loan balance, the repayment is the value of the shares at that time.

Loan-funded shares are valued and expensed for AASB 2 purposes in the same way as market value exercise price options that reduces over its term as dividends are paid.

As the employee acquires the shares at the start of the arrangement at their market value, any gain at the time of sale should be treated under the concessional CGT provisions and only 50% of the gain taxed where the shares have been held for more than 12 months. In contrast, the same appreciation for options would be taxed as ordinary employment income at marginal rates on exercise of the options.

Changes to the Corporations Act 2001 with effect from October 2022 mean loan funded share plans are eligible for ESS relief from the various regulatory requirements.

Given these benefits, it is not entirely clear why we do not see more of these structures across the ASX 300. Some issues can include:

• They are not common so require good communication with stakeholders to ensure a well-informed understanding. Attaching a liability to an employee’s remuneration may foster a negative perception without further explanation.
• Administration can be more involved and needs careful planning to avoid adverse tax implications.
• Some institutional investors may not support their use. Companies with US investors require greater engagement given that these plans cannot be used in the US.
• Loan-funded share plans work well in Australia but are not effective for employees in most other countries.
• One of Australia’s proxy advisers, ISS, is not supportive.

Boards and management would do well to, at least, consider the pros and cons of a loan funded share plan when next reviewing their incentive framework.

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