LTIP - 68% return / year?

MarkCT

Hi everyone

After joining a new company I have been invited to join their long term incentive plan (LTIP) which is something I have not come across before. It is a salary sacrifice scheme where the company take pre-tax income, and award 3 x the cash value in company shares which vest over 3.5 years (40% after 1, 60% 2, 85% 3 and 100% 3.5 years) before they can be exercised.
You owe various taxes when you sell, but I have done some number crunching and found that even assuming the share price stays the same, in 3.5 years you will end up with 2.395x the amount you put in after taxes, (a return of 68% per year). Even if the share price halves, you will end up with 1.2 (a return of 5.7% per year).which isn't too bad.

There is no limit on how much you can put in so this got me thinking about the pros and cons of putting your entire salary in. By using savings to replace your income for 3.5 years and then use the share profit to continually pay yourself an income, you can in theory 2.395x your income.

Other than the argument against doing this for diversification reasons (e.g. if you loose your job, you would loose your income and investment), can anyone think of any reasons against this.

Thanks in advance for your help

Evil_Egg

I'm not sure you can salary sacrifice to below minimum wage?

eskbanker

You seem to be suggesting that the share price halving would be the worst-case scenario, what if it isn't?

However, if you're saying that you could live off savings for 3.5 years then you perhaps have enough behind you already to be able to afford what would seem to others like a crazy risk?

Edit: you may wish to revisit your number crunching anyway:

MarkCT wrote: »

assuming the share price stays the same, in 3.5 years you will end up with 2.395x the amount you put in after taxes, (a return of 68% per year)

Turning 1 into 2.395 over 3.5 years isn't a 68% return on your investment but just below 40% as a straight-line annualised rate or sub 30% as a compounded annual growth rate....

MarkCT

Thanks both for your comments

Evil Egg - not considered this, I will have to look into it.

Eskbanker - Good point, but I am aware of the potential of loosing it all (as with any adventure into the stock market), but as the share price would need to drop to 41% of its original value for an effective 0% return, my opinion is that this is a more appropriate risk than most investments that don't have this buffer.

Tom99

Its high risk but, as you say, there is a buffer. Can you sell the 40% in 1 year?

How much you risk probably depends on the company, small start-up v multi national would make a big difference.

masonic

MarkCT wrote: »

Evil Egg - not considered this, I will have to look into it.

Evil Egg is correct, but you should not be putting in anything close to the sum required to take your salary down to minimum wage.

Eskbanker - Good point, but I am aware of the potential of loosing it all (as with any adventure into the stock market), but as the share price would need to drop to 41% of its original value for an effective 0% return, my opinion is that this is a more appropriate risk than most investments that don't have this buffer.

This is not comparable with "any adventure into the stock market". It is single company investing, which is much higher risk than a typical mainstream investment portfolio, even a high risk mainstream investment portfolio. And it's an ultra high risk investment in your employer, so if they go bust you'll lose the money they paid you and your job. The opportunity is well worth taking advantage of with a small percentage of your salary.

pjread

How's it structured - RSU's? I presume the employer is a plc?



3x value based on what price - midpoint over a month or spot/closing price on a single day? (latter adds risk - but that swings both ways)


What about tax liability on exercise/release - are you covering employers NI?


What conditions are there to the instrument - do they exercise immediately on termination of employment, or do they lapse?


It's probably a good thing, and 40% yr1 at 3x multiplier sounds good on paper, but there are definitely details I'd want to cover off before going mega-extreme on it.



(although my mind would tend in the same direction as yours if I could satisfy those questions!)


I'd definitely suggest selling them at release though if you do this, or at least the significant majority. You don't want everything concentrated in the equity of one company long term.

redpete

I'm in a share incentive scheme with a different structure, up to £150 (pre-tax) a month buys shares at market price, one free share for every three bought. Can be sold tax free after 5 years.

Other than the argument against doing this for diversification reasons (e.g. if you loose your job, you would loose your income and investment),

I mitigate this by selling shares as soon as I build up £1000 worth that I can sell without incurring tax liabilities. Once rolling it keeps the amount at risk to a collapsing share price within comfortable limits. (I learnt this lesson when made redundant from another company whose shares had gone from £12 to a few pence by the time I left.)

Alexland

MarkCT wrote: »

the share price would need to drop to 41% of its original value for an effective 0% return

My mum lost around 80% on her employee purchase shares when the company was badly damaged by the global financial crisis. Still at least her DB pension scheme paid out ok.

Alex

Reed_Richards

I used to work for a North American tech. company. It was said that if instead of buying the company shares at around their peak price you had bought bottled beer then you would have ended up with more money from drinking the beer then claiming the deposit on the bottles (you can do this in North America) than the money you would have got by selling your shares after the share price had crashed (which was a consequence of the dotcom bubble bursting).
I should add that I ultimately lost my job as a result of the financial difficulties the company had got itself into. So the worst case scenario is that you lose most of the salary you had invested and also lose your job.

Johnnyboy11

Ask your postie how his free RMG shares are doing...
Then reflect on your own options.