Share options – how to incentivise your employees

Share options have become a popular way of attracting, incentivising and retaining staff, especially for small businesses or start-ups who can’t afford to offer high salaries.

Having a real stake or equity in a company can be very appealing to employees and can motivate them to work even harder for the long-term success of the company. Through stock options schemes, Facebook has created a number of millionaires, as have other companies in Silicon Valley and elsewhere.

While there is no guarantee it will do the same for your staff, it’s not hard to see the appeal and the potential benefits of the scheme. So, how exactly does it work, and are there any disadvantages to offering share options in your company?

What’s in it for you?

One of the main benefits to you as an employer is that by offering staff share options, you don’t have to pay out large salaries up front and can hang on to any cash reserves or reinvest them in the meantime. The main disadvantage is that you are giving away equity in your company or will be when/if the employee exercises his or her right to buy the shares at a fixed price. This will also mean a dilution of any other shareholders’ equity, including your own, of course. That said, when a share option plan is ‘vested’ and the employee takes up the share option, the business will get an injection of capital.

What’s in it for them?

As well as certain tax advantages, another benefit of share options is that if the business prospers, the value of the employee’s shares increase. Employees may also feel a greater commitment to the company and a real sense of ownership, by having a stake in the business. On the other hand, if the company doesn’t perform well over time and stock doesn’t increase in value, the options may prove to be worthless!

How does it work?

The exact terms of individual share options are determined by the company, but, broadly speaking, an employee has the option of acquiring shares at a fixed point in the future. Conditions will apply, such as if the employee quits before the vesting date, he or she can only take up a smaller number of shares. There are two types of share option schemes used by small businesses in the UK: Enterprise Management Incentive (EMI) schemes, and Unapproved Share Option schemes.

EMI schemes

A tax-advantaged scheme that can work well for the company and the employee who is granted the share options, this is a popular scheme with new or growing businesses. To qualify, the following conditions must apply:

  • The value of the trading company cannot exceed £30 million.
  • There are fewer than 250 employees when EMI options are offered.
  • Shares must be ordinary, non-redeemable shares.
  • Options on the shares should be exercised within ten years of being granted.
  • Market value of the option should not be more than £250,000 per employee.
  • Employees must spend at least 75% of their working time, or 25 hours per week, as an employee of the company.
  • Employees should not hold more than 30% of the shares of the business.

The list above is not exhaustive and other conditions may apply, such as the trigger point when employees can exercise their right to buy shares. Terms of any share option must be set out in writing. For clarity on tax, and to ensure the share options granted under EMI qualify, you should get clearance from HMRC before going ahead with the scheme.

Unapproved share options

Unapproved share options can be offered to staff, non-executive directors and consultants who don’t qualify for HMRC-approved share options, such as EMI. Some features of this scheme include:

  • There are no restrictions on the amount of equity awarded.
  • No restrictions on the value placed on underlying shares.
  • Unapproved options may be awarded for shares in UK companies and/or foreign subsidiaries.
  • Exercise of unapproved shares can be tied to the future sale of the company.

Again, this list is not exhaustive and you should always seek professional advice before deciding which of the two share options is best for your company. It’s also important that whichever option you choose, you make sure the terms and conditions attached to the share options are fully documented.

Why not just issue shares?

If you grant or transfer shares to an employee, they will be listed as shareholders in your company in the register of members. This will mean an immediate dilution for existing shareholders. Depending on the type of share, they will be entitled to certain rights such as dividends, the right to vote, and a share of proceeds from the sale of the company. There are also immediate tax implications for the employee issued with the shares.

Tax-efficient protection for directors

  • limited company life cover