Employee Share Schemes – Gently Does It!

Posted by admin at 15:51 on 13 Feb 2017

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We're often contacted by private company owners who are keen to implement share plans for their employees quickly. They've heard about the positives – employee commitment, improvement in productivity – and for some plans like Enterprise Management Incentive (EMI) and Share Incentive Plan (SIP) the tax advantages sound too good to be missed. They're fired up and ready to go, and they want to move fast.

Our advice at RM2 is almost always that it's a good idea to step back, slow down and look at the basics.

Here are 5 key points to think about before you press the Go button – and the first one is the most important.

Why do you want to use a share plan?

It's easy just to say, to tie in employees in the long term, to attract new recruits, to drive the company towards an exit. All those are excellent reasons, but they are often generic. Each company is different, with its own challenges and goals. Think about what you want a share plan to achieve. The design and detail will flow from your end objective, but if your end goal is not defined, it will be very difficult to establish a share plan that works for you and your company.

All employees or some employees?

Like democracy generally, including all employees in your share plan has advantages and disadvantages. On the plus side, it's fairer, it makes everyone feel involved, and it may help make all your employees feel like owners and drive the company forward. On the other hand – will all your employees be motivated by share ownership? Do they all "deserve" a stake of your carefully established business?  If all are involved, what effect will this have on your equity pool and dilution limits – is there enough to go round? And, finally, if you include all your employees now, what about future hires? Will you keep making awards to everyone, or do you risk disgruntled new hires who weren't in at the beginning? - Go back to question 1 and think about what your share plan is intended to achieve, and the answer to this question should become clearer.

Should you use shares or options?

An option is a promise to the option holder that he can buy a share in the future at a price set today. Until the option is exercised, the option holder has no rights to votes or dividends. Once the option is exercised, and shares are acquired, it's a different story. Unless you create a different class of shares for use under your share plan, your employees will have the rights to receive dividends, and the right to vote on their shares (albeit probably without any controlling influence). Again, the answer to this goes back to question 1 – what do you want to achieve? If you want employees to really feel like shareholders, then shares are probably the way forward. If you want to drive your company towards a sale, then an exit-only option may be a better approach.

What performance conditions should you use?

You can attach performance conditions to your share plan arrangements and like any other performance measure they should be smart, measurable and achievable. If your employees don't understand their targets, it will be impossible for them to work towards them.

As to what your performance conditions should involve – go back to question 1. What do you want to achieve with your share plan? If you know that, the performance conditions will write themselves.

How much equity?

As a rough rule of thumb, setting aside 10% of your company's equity for a share scheme isn't going to scare the horses – even where there's an outside or venture capital investor.  However, consider the returns to your employees – for example, if exit only options are involved, what's the likely gain for an employee with a certain percentage of the equity? If dividends are part of the plan, what level of dividends are likely to be paid out? What about the dilution for the owners? And – very importantly – a 1% stake now may not be a 1% stake in the future – what if future investors result in dilution? What effect will that have on existing shareholders and option holders? Once more, go back to question 1 – if you've a clear idea of the reason behind the share plan, you are well on the way to establishing the level of equity required for your plan.

Share plans – especially in smaller private companies – can be set up quickly, and easily. But a private company owner needs to think very carefully about the plan's objectives; after all, it involves giving away a certain amount of a company that he or she may have spent years building up. Once the foundations of the plan are laid, the rest should come easily – otherwise, the old saying "more haste, less speed" may well apply.

For more information on any of the content covered in this blog, please contact Sarah Anderson via Sarah.Anderson@rm2.co.uk or a member of the RM2 team on 020 8949 5522.