Loan funded share plans

We previously looked at market practice in April 2018 (see HERE).

Loan funded share plans have been used by ASX-listed companies and large private companies (especially private equity portfolio companies) for a long time.

A loan funded share plan has the following features:

  • A loan is granted to an employee for the sole purpose of purchasing company shares
  • The shares are purchased at market value – so the structure is not captured by the employee share scheme rules in Division 83A of the Income Tax Assessment Act 1997
  • The loan is limited in recourse to the lower of the value of the shares and the loan value at the date of repayment
  • The loan may be interest-free or at interest
  • As the structure has the economic effect of an option with an exercise price, it is accounted for as an option under AASB2 – the grant date fair value is amortised over the service period.
  • For the individual executive, the shares are held as a capital asset and, on disposal, subject to capital gains tax (CGT) rather than ordinary income tax like the typical employee share scheme structures

This structure more closely aligns employee interests with investor interests – as the employee owns the shares any increase in share price will be a net gain to the employee after repayment of the loan, along with dividends. It is also tax-effective for the employee.

Loans are limited recourse to the value of the underlying shares with the maximum amount to be repaid limited to the initial loan value.  Since the shares are acquired at the time of issue rather than at vesting, any increase in share price will be treated as a capital gain rather than an income gain. As such, an employee can benefit from the concessional CGT discount of 50%.

Another benefit of the shares being acquired at the point of issue, is that dividends will be paid from that point. It is better aligned with shareholder interests than an option plan, which only rewards for share price growth. A loan funded plan ensures employees consider the 2 elements of total shareholder return – share price growth and dividends. The employee can also receive the benefit of the dividends.

There are disadvantages with loan plans:

  • They are more complex to understand, and more costly to administer. Forfeiture of loan shares when performance measures are not met needs to be carefully managed to avoid adverse outcomes.
  • Some institutional investors do not support loan funded plans. Companies with US investors may need to engage more given such plans are not permitted in the US.
  • Following on from the above, executive loan funded plans are not permitted in some countries.
  • One of Australia’s main proxy advisers is not keen on loan plans.

Given their alignment with shareholder interests, and tax-effectiveness for employees, they should be more popular. They are not.

When we last reviewed (April 2018) loan plans in the ASX 300, we found 10 companies used the structure.  Since then, 5 of those companies are no longer listed on the ASX, and three have discontinued use of their loan plans.

On the other hand, there have been additions and this year’s review discloses six companies using loan plans. This count does not include the companies that use full recourse loan plans.

Full recourse loan plans are not like limited recourse plans in many respects. The most significant of the pros and cons of full recourse plans is the adverse impact on employee motivation when there is a fall in share price. The employee remains on the hook for the loan value notwithstanding the lower share price.

Limited recourse loan plans will continue to be widely used by unlisted companies – although they need to be careful of the ‘deemed dividend‘ rules of the income tax legislation.

They can also be used by ASX-listed companies although you will not find many such companies to reference.

© Guerdon Associates 2024
read more Back to all articles