Mary Schofield, Partner, Lovewell Blake
In today’s knowledge economy, the contribution which key members of staff can make to the success of your business is greater than ever.
With this in mind, a question which is particularly relevant to fast-growing businesses is this: how do you hold onto your winning team?
Perhaps you are building your business and seeing it start to gain traction in the marketplace, and you are confident that you have a hit on your hands. The one thing which might dent that great feeling of imminent success is if your winning team decide to walk away.
Or perhaps you are at the stage where you are seeking investment to take your business to the next stage. Whatever kind of backers you are courting – traditional banks through to crowd-funders – they will all want to know that the star performers who have got your company to where it is now are going to stick around. They may well make it a condition of their investment that you demonstrate what you have done to tie them into the business.
There are few entrepreneurs who haven’t given this issue some serious thought. And in the new, non-hierarchical business world, company owners are much more switched on to thinking about share options at a far earlier stage of the business’s development. But structuring this in the right way is key, both in effectively retaining that key talent, but also ensuring it’s done in a financially and tax-efficient way.
There’s a scheme for that
Fortunately, there is a very neat solution which is increasingly popular amongst growing businesses: the Enterprise Management Initiative Scheme (EMI). An EMI share option is an agreement between a ‘key employee’ and the company which lets them buy an agreed number of shares, at an agreed price.
There has been widespread adoption of EMIs in the tech sector, where a Silicon Valley-style performance culture and ethos is more prevalent. But actually the scheme is suitable for most developing businesses which are dependent on key personnel for driving forward growth.
They are particularly relevant where there is a separation between the business’s owners and the person or people who are actually undertaking the important activity. The beauty of the EMI scheme is that you can identify individuals within a group, rather than making it universally available across the whole company.
There is a cultural element here: it’s about accepting that those whose knowledge or skills are crucial to the business should be able to share in the company’s success. This is particularly relevant when that person is someone who has only been in the organisation for a short period of time (a recent graduate, for example), and who therefore wouldn’t traditionally expect to be a shareholder straight away.
There is a new generation of workers who know they have these key skills, and who will be attracted to employers who can demonstrate that they are prepared to reward them with a stake in the business.
It also sends out a great message to investors – it’s a statement of intent about your company’s ambitions. Many will want to be reassured that you are taking steps to attract and retain the talent which will bring them a sound return on their investment, and having an EMI in place signals that a business is serious about tying in a winning team.
and things to think about
Aside from the obvious advantages of having a system in place which will attract and retain key talent as well as reassuring investors, there are significant tax advantages for both employers and employees in adopting the EMI scheme.
One key benefit is that the scheme qualifies for Entrepreneurs Relief, which means that capital gains tax is payable at the reduced rate of 10 per cent where certain conditions are met. Perhaps more importantly, given that many beneficiaries of the EMI scheme will be at an early stage in their career, if structured correctly no tax is payable at the point the option is exercised. Therefore an EMI scheme can have significant advantages over an unapproved share scheme.
So not only does the employee pay significantly less tax, but there is no tax liability until they cash in their shares, encouraging them to hold onto their investment for longer (i.e. they won’t have to sell some or all of their shares immediately to pay a tax bill at the point of exercising the option).
For the employer, granting options in this way is more attractive than simply giving shares as an immediate incentive, both because those options can be dependent on growth targets or other KPIs being met, and also to avoid complications if the individual does leave the company in the meantime.
However, setting up an EMI scheme is not without up-front cost for the business, at a time when it might be looking to allocate all of its spare resources into driving growth. Nor is it a magic bullet: staff can and do still leave, tempted in many cases by more generous packages from other companies.
Getting the structure right is also important – for example building in a shareholder agreement to ensure that if the employee does leave after exercising their option, the company has the right to buy them back before they are sold to a third party.
But there is little doubt that demonstrating a commitment to key people in this way minimises that risk, even if you can never remove it altogether. Doing so does require a certain degree of egalitarianism on the part of the business owner, and a genuine belief in the individuals they are incentivising.
It’s not just about the money
One final thing to think about is that the individual’s priority might not only be financially based. This is increasingly common amongst millennials, who value other factors such as work-life balance, opportunities for flexible working, flatter structures and employers with a strong CSR commitment. Putting a share option scheme in place is not enough on its own; it must be accompanied by a genuinely inclusive culture.
There are cynics who say that loyalty – whether from employer to employee or vice-versa – is a thing of the past in business. That’s not actually the case. But as has always been the case, loyalty has to be earnt, and there is no better way to generate that sense of loyalty than creating a real feeling of ownership, in every sense of the word.