For many business owners, there comes a point when salary increases alone are no longer enough to retain and motivate key employees.
Perhaps you have a long-serving manager you’d like to keep engaged for the next phase of growth. Perhaps you’re thinking about succession planning. Or perhaps you simply want your best people to think and act more like owners.
Employee share schemes and other ownership-based incentives can be an effective way to align the interests of employees with ownership objectives and the long-term success of a business. However, there is no one-size-fits-all solution, and the right structure depends on what you are trying to achieve.
Start with the desired outcome
The most successful arrangements start with a clear objective.
Common goals include:
- retaining key employees;
- rewarding exceptional performance;
- attracting talent in a competitive market;
- introducing future owners into the business; and
- supporting long-term succession planning.
Once the objective is clear, it becomes much easier to determine whether equity is appropriate and, if so, what form it should take.
Understanding employee share scheme options
Many business owners are surprised to learn that employee ownerships incentives sit on a spectrum, ranging from simple profit-sharing arrangements through to full ownership.
Profit-share and bonus arrangements
At the simpler end are profit-share and bonus arrangements. These can be highly effective where the goal is to reward performance without introducing additional shareholders or changing the ownership structure of the business.
Phantom equity
The next step is often a form of phantom equity. These arrangements allow employees to participate in the growth in value of a business without actually owning shares. They can offer many of the motivational benefits of ownership while avoiding some of the complexities associated with bringing new shareholders into the company.
Share option arrangements
For growth-focused businesses, share options are another common tool. Options can give employees the right to acquire shares in the future, allowing them to participate in future value creation if certain conditions are met. These arrangements are particularly popular where the business expects significant growth or a future sale event.
Employee share ownership
At the ownership end of the spectrum are restricted shares and ordinary shares. These arrangements involve employees becoming actual shareholders and are often used as part of a business succession strategy or where owners want key people to have a genuine stake in the future of the business. While potentially powerful, they also introduce additional governance, legal and tax considerations that need to be carefully managed.
Bringing employees into ownership is a significant step
Giving shares to employees is about much more than sharing profits.
Shareholders can have rights to information, voting rights and other protections which continue long after the original incentive has been granted. Issues such as future funding rounds, employee departures, valuation methodologies and buy-back rights should all be considered before any arrangement is implemented.
We often see difficulties arise not because the original intention was wrong, but because key questions were not addressed at the outset.
Consider the tax implications
A well-structured arrangement needs to work from both a legal and tax perspective.
The tax treatment can vary significantly depending on the type of incentive being offered. Valuation issues, reporting requirements and the timing of tax obligations can all influence whether a scheme delivers the intended result for both the business and the employee.
It is important to understand these implications before making commitments to employees.
Choosing the right structure
The best employee incentive arrangements are usually the simplest ones that achieve the desired commercial outcome.
Whether the goal is retaining a key manager, facilitating succession, rewarding performance or sharing future growth, careful planning at the outset can save significant cost and complexity later on.
If you are considering introducing an employee share scheme or another ownership-based incentive arrangement, obtaining legal and tax advice early can help ensure the structure supports your objectives while protecting the long-term interests of the business and its owners.
