Let’s start from the beginning.
Is it that common to grant options to employees in the UK?
The total number of companies where employees have been granted options or been awarded shares has generally been rising since 2009–10, the data shows that there are 13,330 companies operating Employee Share Schemes in the UK in 2017–2018 (48% increase since 2007–08). The total increase is driven by the large rise in the number of companies granting EMI options.
How does granting options lead to motivation, recruitment and retention?
With most trends, we have to look at America, the home of the first Employee Stock Ownership Plan (ESOP). It began with by Louis Kelso in 1956 when the employees of the Peninsula Newspaper in Palo Alto purchased the company from the retiring owner. It was achieved through securing a loan against future profits and the shares were then held on trust.
A key aspect of being an employee owner is the financial reward gained from the fruit of their labour; that a share of the profit goes to those who helped to create it. Allied with reward is how people are managed to create the necessary profit and how performance management is carried out when the workers and managers are both co-owners
The rights of ownership are made up of three strands: possession, influence and information.
They expand as the following: (1) The right to possession of some share of the owned object’s physical being and/or financial value,(2) The right to exercise influence (control) over the owned object, and (3) The right to information about the status of that which is owned.
Employee ownership is argued to have a beneficial effect on both employee-owners and the overall businesses. Research by Matrix Evidence (2010) suggests a number of benefits from employee ownership. Benefits would be having a voice regarding management decisions and staff being rewarded better both financially and intrinsically. In certain conditions there are productivity gains from employee ownership. This is most obvious when there is a definite link to involvement in decision making. We also see a comparative increase in employee commitment and satisfaction.
However, the two main obstacles to overcome are the lack of awareness of the option of employee ownership from two perspectives, from many current and future employees but also from founders looking to grant equity to their team. The second being that outside of the EMI options scheme the disadvantageous tax implications.
But first back to basics — what actually is an option scheme? It is a mechanism that allows an individual the right to buy a certain number of shares (share option)at a fixed price, some period of time in the future, within a company.
There are several Options plans available, but the EMI (Enterprise Management Incentives) Share Option Scheme is by far the most generous mechanism with which to award employees with equity in your company, and the most popular one (with 84% of the companies offering it). Furthermore, the data shows that 98% of companies offering a scheme, only offer EMI.
Shares vs. Options: What’s the difference?
Instead of a share, where someone owns a part of the business outright — an option is the right to buy a share at a fixed price.
Instead of giving traditional shares to members of the team that makes them susceptible to a large tax bill which worse case worse may result in them selling their shares to cover the chargeable income and gains.
This is why we recommend EMI options as they do not attract any tax when they are granted or exercised, but only when they are sold so normally when there is an exit or an IPO . Moreover, when they are sold the employees will only pay 10% CGT on any profits that they make from the EMI options!
Introducing Vesting
Below are examples of vesting — essentially putting conditions on equity that you give out to employees. You obviously don’t want to grant someone a slice of your company, only for the next day them to leave. But as a Founder, you’ll need to decide what kind of scheme is right for you
There are broadly three types of Option Scheme
- Exit only — any employee that’s with the company when it’s sold cashes out — but if you leave early — you’re out of luck
- Milestone based — if an employee hits a certain milestone (e.g. £1m in sales), they earn a certain number of Options
- Time Based — an employee will earn their shares over a set period of time — normally 3–4 years.
It’s important to have a framework to abide by when looking to grant equity to stakeholders. Useful questions to ask when creating a framework for your approach are as follows:
What do you want your company’s compensation culture to be?
Which is most important: to be fair, to be consistent or to be competitive?
What’s your approach to attracting new hires?
What’s your approach to promotions and retaining talent?
How does this all relate to the base salary (and any bonus) that is paid?
For more detail on options and strategies for determining what quantum should be awarded to certain employees, read Fred Wilson’s tiered methodology or the WealthFront Model or Index Ventures framework
These are from the U.S . perspective, but still provide a useful starting point.
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