How share schemes build wealth

2012-10-13 11:56

If you own share options at work, think twice before leaving your job

A recent study found that company share option schemes do not necessarily motivate staff to remain with the company and more than half of employees would rather receive alternative incentives.

This despite the fact that share options can be a significant wealth creator, something Kumba Iron Ore employees can attest to.

Craig Gradidge of Gradidge-Mahura Investments says the results of the study, which were part of a master’s thesis at the University of Pretoria, are not surprising as most employees do not necessarily understand the value of their share options.

The wording is complicated and the calculation around tax can be very confusing.

“This complexity often results in people just shutting down,” says Gradidge, who adds that it is also difficult for employees to understand the long-term benefits of these schemes, which often only vest three, five and even up to 10 years later.

They would rather have incentives that provide benefits now.

“They don’t realise that it is no longer their pension cheque that is the big number, but their share scheme,” Gradidge says.

Black employees have especially benefited from share schemes where companies have used staff participation as part of addressing the ownership element of black economic empowerment (BEE) requirements.

GM Investments undertook a survey of a random sample of 10 large listed companies and analysed which partners they chose to meet their BEE ownership requirements.

All the companies used a range of partners, including employee share option schemes, strategic partners, broad-based participation through an empowerment trust and/or public participation through issuing shares to the black public.

Of these, the highest percentage, more than 33%, went to employee share schemes, especially where the majority of the staff were black.

In some cases, staff received equal numbers of shares, irrespective of seniority.

In this sample the total value of the BEE ownership deals came to R56 billion, of which R18 billion went to staff.
Some staff schemes have resulted in significant wealth vesting in the hands of employees.

Recently, employees of iron ore producer Kumba each received a payment of R350 000 after tax from their share scheme and employees at investment management company Coronation have also benefited massively from their share scheme as the company share price increased from R4 to R30 over eight years.

Staff at Makro benefited from the Walmart deal, which caused the staff share scheme vesting date to accelerate, allowing them to realise their share options earlier.

Unfortunately, not all share schemes deliver the same returns as it all depends on the performance of the company during the period of the share scheme.

While Kumba employees are laughing all the way to the bank, employees who participated in platinum company Impala’s share scheme received only a few thousand rands when their shares vested.

Some unlisted companies provide share participation for their employees, although it is often more difficult to calculate the value as there is an element of subjectivity in valuing the shares.

However, if an employee has shares in the unlisted entity that then lists, they could make significant profits.
 
If you are a participant in a company share scheme, it is definitely worth finding out what they are worth, or could potentially be worth, before you decide to switch jobs.

Fast facts
Share schemes are usually structured so that the dividends (income paid by the company to shareholders) pay off the acquiring costs of the share.

For example, a company may issue shares to staff at R10 per share.

A loan is created against this and the dividends paid by the company each year are used to settle the loan.

Therefore, a company with a high dividend yield, as was the case with Kumba, will settle the debt quickly and the employee will receive a far higher return.

If at the time of vesting (when the employee takes ownership of the shares) there is still debt outstanding, the employee will only receive value net of the outstanding loan.

This may mean that the company has to sell some of the shares to settle the outstanding debt.

When an employee receives the shares, even if they do not cash them in, they will have to pay tax because it is seen as income.

For example, in the case of Kumba, employees received more than R570 000 in shares, but after tax the value was reduced to R350 000.

Should you cash in or keep the shares?
When the shares vest and are transferred into your name, you have the option of selling or keeping the shares.

Less than 10% of employees hold on to the shares. However, Gradidge says there are several considerations:

Debt
If you have significant short-term debt, use some or all of the proceeds to pay off debt first.

Diversification
If you do not have debt, you need to calculate what percentage these shares make up of your total investments.

You do not want to be overexposed to one company, so if it makes up more than 10% of your portfolio, consider selling and investing the proceeds elsewhere

Dividends
Last year some shares that vested were paying dividend yields of more than 12%. That means you would have received an income equal to 12% of the value of the shares. A bank account is paying out 5% at most.

If you do not need the income, invest the dividends into another investment to maximise your wealth creation potential and reduce risk in your portfolio.

Cycles
Consider the industry you work in. Firms in cyclical industries such as mining or information technology experience high share price volatility.

If the share price has done well in previous years, you may want to take some profits.

Other industries like food retail have far more stable returns, such as Pick n Pay and Shoprite, and you may benefit by holding on to them.

Tax
If you decide to keep the shares, you will still have to pay tax, so you need to ensure either you have cash available or you need to sell enough shares to cover the bill.

What you should never do is squander a once in a lifetime opportunity by using the money to boost your lifestyle.

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