Employee share schemes are a useful tool for bridging this gap and allowing smaller companies to offer more competitive pay packages.
While the strategic objectives of businesses vary, the key purposes of a share incentive plan from the perspective of the employer are usually set out as:
- recruitment of talent;
- retention of employees;
- incentivisation;
- alignment of the interests of management with the interests of shareholders; and
- reward of employees.
These potential motivations to operate a share scheme are discussed in greater detail below.
Recruitment
The use of share incentives can be an important tool in the recruitment of management, acting as an effective way to attract potential employees. As mentioned, this can be particularly useful for start-ups and companies scaling up. While they may not be able to offer as high a salary as other companies, businesses with high growth potential can offer a share incentive to encourage skilled or experienced management to join the company by rewarding them out of its growth (and specifically out of the growth in its share value). This can effectively allow a smaller company to ‘punch above its weight’.
Retention
It is common for share-based awards to employees to include a provision that the employee cannot acquire the shares and/or sell the shares until either the expiry of a certain period or until a certain ‘qualifying’ event occurs (such as the sale of the company, or it becoming publicly listed on a stock exchange i.e. an 'exit event').
There are also likely to be provisions that if the employee leaves the company, they will lose their right to the shares. This effectively encourages the employee to stay with the business, because if they choose to leave then, in general (subject to the exercise of the company's discretion for 'good leavers'), they will not be permitted to get any form of return from the share-based incentive.
Incentivisation
The use of share-based awards can be an effective tool for motivating employees. By their nature, such awards incentivise employees to work towards share price growth and, if the shares are only to be delivered on an 'exit event', to work towards delivering that event.
Alignment
Another potential reason to introduce a share scheme to reward employees, is to align the interests of key management with those of shareholders. This can encourage these employees to consider longer-term interests than they otherwise would, to promote future growth in share value and maximise the gain on the relevant shares, as opposed to focusing purely on short-term profits or working practices.
This can be particularly important as a way to reassure shareholders that key employees have some ‘skin in the game’ through share awards, as well as promoting the achievement of a common goal between the investor and management (such as a sale of the company at a future date, or an IPO).
Reward
Finally, and most obviously, a share scheme is an effective way to reward employees. It has the advantage of being a cheaper way to give a potentially significant reward to the employee. This is because where new shares are allotted to satisfy awards, the cost is borne through shareholder dilution rather than using cash to acquire existing shares. The employee has the advantage of any increase in value on the shares, which could be substantial, particularly on a flotation or sale of the company. Share-based awards can also, if structured through a tax-advantaged scheme such as the enterprise management incentive (EMI) regime, be subject to significant tax breaks, both for the employing company and for the employee.
If you are considering whether an employee share scheme is the right option for your company or would like to find out more you can contact one of Shepherd and Wedderburn's dedicated share plan specialists.