Keeping your employees motivated and rewarding them for their excellent work is really important, no matter what stage you're at with your business. It enables you to attract (and keep!) the best talent, which means you can grow your business more effectively. However if you're running a start-up, you're less likely to be able to compete with the benefits and budgets of large, established companies. Time to think outside the box and consider other ways of incentivising your employees - such as through share-based schemes.
Sebastian Salt is a corporate lawyer with Wright Hassall LLP. He specialises in the design and implementation of employee incentive arrangements. Here he shares with us some insight into the world of incentives, and how it can help motivate employees.
A motivated workforce is central to the success of any business. In the context of an economic environment where many employers are not able to increase salaries and pay large bonuses, share-based incentives can provide a powerful mechanism to motivate employees - and this is especially relevant to startups.
At their core, share-based incentives act as a motivational mechanism by giving employees a vested interest in the performance (and growth) of their employing company. However, such incentives can take a number of forms and can be designed to meet the objectives of any size or type of company with a share capital. The most appropriate incentive will usually depend upon the employees the business is aiming to motivate, and the behaviours it’s seeking to promote.
This article focusses upon two particular types of share-based incentive available to UK companies, and also highlights some recent findings relating to the use of share-based incentives in the UK.
The findings
The UK Government sees share incentives as a good thing due to their wider economic benefits and their ability to promote and foster entrepreneurial behaviour. This belief is backed up by a variety of sources of academic research which indicate that businesses which operate a share incentive arrangement are generally more productive that those which do not. This is considered to be because employees who own shares are likely to work harder to grow the value of their employing company. HM Revenue & Customs also publishes annual statistics in relation to the use of Government-backed share plans. These statistics show that such arrangements are becoming increasingly popular, suggesting that many businesses now see share based incentives as a key component in promoting employee motivation and retention.
Flexible and tax efficient incentives
Choosing the right form of incentive is pivotal to ensuring that their motivational impact is maximised. Tax can also play a key role, with the spectre of losing up to 47% of any growth in value in income tax and National Insurance contributions being a central design issue. Two forms of share incentive that offer flexibility in their design and tax efficiencies are outlined below.
Enterprise Management Incentive (“EMI”) share options
EMI is a government-backed arrangement which allows certain qualifying companies to offer share options (rights to acquire shares in the future) to qualifying employees on a tax-efficient basis. EMI can be used by both private and smaller listed companies alike (provided they meet certain qualifying conditions) and either for targeted grants to specific key employees or on a wider (even all employee) basis.
A key benefit of EMI is that it offers significant flexibility, such that the options and underlying share rights can be tailored to meet specific objectives. For example, it is possible to link an employee’s ability to acquire shares through the option to a wide range of personal as well as business targets. The options (and hence the acquisition of shares) can also be linked to continued employment to encourage the retention of the employee within the business. The flexibility of EMI can therefore be used to motivate employees to behave in a certain way – whether this is to drive business growth or encourage them to achieve personal outcomes.
EMI schemes have been a real success, with HMRC statistics stating that 8,610 companies use them (as at 6 April 2016). Research has also been conducted in relation to the perceived impact of operating an EMI arrangement from both an employer and employee perspective. For employers there was a perception that EMI helped to retain and motivate key staff, and employers who had used EMI wanted to continue using it in the future. For employees there was a perception that EMI options helped promote a feeling of ownership and a desire to remain part of the business.
Growth shares
Growth shares are essentially a new class of shares in a company which are issued to employees. Such shares entitle the holders to share in a proportion of the future growth in value (rather than the existing value) of a company. In many cases, a further hurdle is also set (typically slightly in excess of current value) at which point the employees’ growth shares become entitled to share in value.
Employees may benefit from dividends on their growth shares but often they will only receive economic benefits from their growth shares on an exit or other realisation event to the extent that the hurdle is then exceeded. From an existing shareholder perspective, growth shares help to manage any dilution of existing value and motivate key employees to work to generate future growth. They are therefore more likely to be of use for reasonably established companies with strong growth prospects. Growth shares also offer potentially significant tax savings to both employees and the employer, and can be combined with an EMI scheme to enhance these tax breaks further.
Growth shares are commercially flexible and are nearly always linked to continued employment to aid retention of employees. Restrictions can also be applied to the shares in relation to votes, dividends and other shareholder rights. Performance or time based vesting triggers can also be added to tailor the share rights to encourage particular employee behaviours.
Design considerations
While evidence suggests that having a share incentive arrangement will support the financial performance of a company, the true success of any such arrangement relies upon proper design and implementation.
Factors to be considered include:
- how is shareholder value generated and what are the key employee behaviours to be promoted in generating that value?
- what are existing shareholders’ goals for the company?
- who should participate based on the ability to impact on business value and the breadth of share ownership culture that should be promoted?
- how will employees realise value from their shares? Is an exit likely or possible or will the incentives need to confer dividend rights or a right to sell to shareholders in order to help employees to see them as being of true economic value?
- how best to communicate the current and future potential value of the incentives to employees?
Conclusion
Recent research indicates that share-based incentive arrangements are becoming increasingly popular and generally have a positive impact from both a corporate and employee perspective.
A wide range of incentive arrangements are available to UK businesses, many of which can be tailored to motivate employees and promote particular behaviours. Getting the design and implementation right is fundamental but with proper thought and consideration to all relevant issues, the motivational impact of share incentives can be significant.
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