Ask the Expert – Maximising value through share incentives

Whether you are a start up business, scaling up or a mature business, a vital question for any business owner is how best to retain and incentivise key management.

In many companies the success of the business and its ability to grow is dependent on the management team as a whole and is rarely reliant solely on its owners.  Key managers play a significant role in delivering a successful business plan and maximising value for shareholders.

It is therefore essential that the senior management team is properly incentivised to ensure they are fully invested in the business and to unlock their full potential.  Using the equity in the business through a share incentive scheme can be a very effective tool to reward and retain key employees whilst also helping to drive the value of the business.

Why use a share scheme

Share schemes can have the following benefits to the business and its shareholders:

1. Incentivise employees to grow the business. Particularly, if the business is looking to scale up, share schemes can act as a powerful incentive to drive growth.
2. Incentivise employees to achieve an exit. The employees’ interests are then more aligned with the shareholders to maximise value on exit.
3. Retention of key employees. Share schemes can be created so the value to the employee is only realised if the employee remains with the business long term or until an exit.
4. Attracting employees. The tax benefits of certain share schemes are attractive to new employees.  Start up businesses can use schemes to offer value in the future where cash flow perhaps does not support higher salaries or traditional cash bonus incentives.
5. Share schemes are tax efficient for the employee and the company.
6. Succession planning. Share schemes can be used to tie in a management team with a view to a management buy out or similar succession plans in the future.

What type of share schemes are available?

There are many share schemes available to be able to allow employees to participate in equity such as share options (approved or unapproved), growth share schemes, share incentive plans or phantom share schemes.  Certain schemes can benefit large numbers of employees but the main focus for SMEs and owner managed businesses should be to identify a small number of people critical to the success of the business.

In order to select which scheme is suitable for any business, the shareholders will need to consider their short and long term objectives and what value is to be provided to the employees through any scheme.

If the company is a start up or early stage business for example, the scheme may be designed so that share options are granted from the outset on terms that the employee only benefits from a percentage of the overall value if there is an exit.   For more mature businesses, which already have a significant value, the share scheme may be designed to provide a percentage of the growth value above the current value of the business.  This type of scheme focusses on the ability of the employee to be able to scale up the business and be rewarded for successfully driving that growth.

Common with all schemes is that the existing shareholders are giving up part of their equity and this should not be given away lightly.

Options are not suitable for all individuals and the employee must see the potential reward for this to act as a true incentive.  There is no point giving away a slice of equity if this does not have the effect of driving growth or achieving the aims of the scheme – for example, if the employees never think that a sale is likely a share option giving them a financial reward on a sale is not going to be much of an incentive.

Tailoring the share scheme

Share schemes, and particularly share options, are very flexible and may be tailored to the specific role certain employees play in the business.  Ways in which you can tailor the scheme include:

1. Setting performance conditions so the value of the share option is only realised once those conditions are satisfied by the employee, that person’s team or the company as a whole.
2. Granting options so the employee only receives shares if there is an exit or sale. – effectively “golden handcuffs” with the added benefit that departing employees lose their rights to shares automatically if they leave prior to sale rather than the more cumbersome method of having to buy back shares
3. Granting options that are only exercisable after a certain length of service.
4. Options can be exercised ahead of a sale to allow employees to participate in dividends.

One of the advantages of granting options instead of employees holding shares is that if the employee leaves the option falls away without any action required.  Options can then be granted to another existing employee or used to attract a replacement.

Tax Benefits

Shares cannot be simply given to employees without significant tax consequences for the employee.  However, there are several tax advantaged schemes available to structure the issue of shares or grant options which avoid these tax consequences.

EMI Options, for example, are a very popular scheme and offer several tax advantages to the employee and the company.   If set up correctly and the qualifying criteria are met, the options and value derived from the sale of option shares is tax efficient for the employees.  There will be no or little income tax and the employee will pay capital gains tax in the same way as the remaining shareholders, also potentially benefitting from entrepreneurs’ relief.

Share incentives are a great way to retain and incentivise employees and we have assisted many companies to design and set up successful incentive schemes.

If you are considering setting up a scheme or would like to know more I would delighted to discuss with you and share my experience.  For more information please contact Adrian Dye at Sintons LLP on 0191 226 7800 or adrian.dye@sintons.co.uk.

(Sintons has been shortlisted in two categories of the North East Dealmakers Awards 2019, named as a finalist in Corporate Law Firm of the Year, and Partner Adrian Dye has securing a shortlisting for Corporate Lawyer of the Year.)

This article featured on Insider Media on the 8th August 2019.