By Louise Torr & Natalie Wallace
Motivating and incentivising your staff has arguably never been as difficult as it has been in 2020. Businesses have to come up with new and inventive ways to ensure that staff remain motivated towards work, whether that is weekly Teams coffee mornings or Zoom call drinks. Psychological aspect aside, not all businesses are looking at strong forecasts for 2021 and are worrying about the conversations they'll need to have with employees next year about pay increases. So what other options are there?
What are share options?
Share options are one way of saving your business money but still incentivising your staff financially. Ultimately, share options are the ability for someone to own a certain number of shares in the company provided certain criteria are met or certain events occur. How or when they own the shares is up to the company.
For instance, staff may be given the full option at the outset or the option may 'vest' over time, meaning each year they get a certain number providing they meet the conditions agreed i.e. time served in the company or hitting certain performance targets. Giving an option does not mean the individual becomes a shareholder in the company, this only occurs when they exercise the option. Again, it is up to the company when this occurs.
The most common scenario is an 'exit only' option, meaning at the point of an exit (which tends to be a share or asset sale) the individual exercises the option immediately before the exit to allow them to sell their shares as part of the exit. From the company's point of view this means the option holders are never shareholders in the company, and from the option holder's point of view it means they do not have to pay for their shares at the point of granting as the payment is just deducted from the remuneration they receive as part of the sale.
EMI share options
While there are a number of different types of share options available, one particular type is EMI share options. This scheme is particularly suited to smaller, growing companies due to the restrictions on these options e.g. less than 250 employees and gross assets of £30 million or less.
The attraction of EMI options is the tax benefit that comes along with it for the employees. Involvement from the company's accountant is crucial in preparing the EMI alongside a solicitor and the accountant would seek approval from HMRC for the valuation of the company and secure as low a share price for the option as possible to try to minimise any tax implication for the employee at the point of exercising the option. It is also important to note that there is only a specific period of time in which the company can notify HMRC that the options have been entered into following the signing of the options, so it is important to have the correct advice around this.
There are a number of reasons as to why right now, in the midst of this pandemic, might be the right time to consider staff incentivisation and in particular share options:
A lot of businesses are currently facing lower valuations than they have previously, which is largely due to the impact of Covid-19. We're all hoping that it is only a short term state, but this is one of the reasons why now might be a good time to look at share options. If you submit an EMI share option valuation to HMRC now, then it is the current business valuation per share price that the employees would pay for the shares which should hopefully mean that a greater increase in value might be received by the time the shares come to be sold in any exit event.
Brexit and State Aid implications
The rules around State Aid are governed at European level and it remains to be seen how this will be dealt with at UK level post Brexit. With the current Brexit Transition Period due to end at the end of this year, in order to avoid any uncertainty associated with State Aid and associated tax benefits would mean acting now, especially given HMRC may take up to six weeks to approve the valuation of any EMI share option.
No financial burden on the company
Putting share options in place may incentivise staff due to the future financial gain they will receive, while allowing the company to save cash in the short term which can assist them through the difficulties faced by the pandemic. Equity in every company is precious though, so please come and speak to us for guidance on an appropriate level of options before discussing with your employees.
Other incentivisation – growth shares
Share options are not the only mechanism to incentivise staff and other options are available, for example growth shares. Growth shares tend to be most appropriate for non-employees but they can also be used for employees. In contrast to the share option, growth shares allow individuals to become shareholders immediately. This type of share can be incredibly flexible, it does not have to meet any statutory requirements or limits and ‘conditionality’ can be applied to protect the business i.e. similar to performance targets discussed above. The logic behind growth shares is the same as options, to attract and retain the best people even if these individuals are not employees. It allows the company to reward their contribution with equity rather than or as well as cash.
Growth shares are shares in the capital of the company, but where the rights are limited so that on a sale the holder will only receive a share in the value of the company above a certain threshold. The shareholder only gets the benefit of the shares if the company grows, hence the term growth shares. This means they will only share in any sale proceeds that are over and above the threshold.
By way of example, if an employee is granted 1% of the share capital of the company with the condition that they can only participate in a sale value above £1m and the company is subsequently sold for £5m, the individual would have a right to 1% of the value in excess of £1m i.e. 1% of £4m. The initial £1m would be split between the shareholders that got the company to that value prior to the growth shares being issued.
Growth shares are not often appropriate unless a company has real value already, so it may not be a suitable option for a startup. However, they can be a great alternative to EMI options for businesses that are not likely to sell in the short term and a great incentive for individuals to assist in growing the business, while allowing the value that has already been generated to be given to those who created that value.
As with EMI options, despite a growth share not being able to get an HMRC agreed valuation, the initial valuation of a growth share is key and needs to be thought through carefully from the outset with support from a tax adviser.
Get in touch – we're here to help
If this is something that you would like to discuss in more detail with us then please get in touch and we would be delighted to assist.
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