Tuesday 17 January 2017 5:51 pm

What entrepreneurs must consider when planning to give employees equity

Until robots replace workers, entrepreneurs will need to think about how to keep their employees happy. But there’s no one-size-fits-all solution. While some are best inspired by cold, hard cash, others may react better to beanbags and PlayStations.

Most entrepreneurs use a variety of incentives. The first step is to work out what’s valuable to the owners and employees. Without doing this, entrepreneurs may well be trying to solve a problem that doesn’t exist or offer an incentive for which there is no demand.

Coming out of the financial crisis, we saw growing interest in employee incentives and equity. Large firms wanted to ensure that the incentives of the workforce were better aligned with the long-term success of the company. Alongside the rise of entrepreneurship in the UK, we have seen a lot more interest in employee ownership, particularly among growing companies.

There has also been a drive to improve the legislation around employee incentives and equity. It’s always a balance for the Treasury – after all, tax benefits may also mean a loss of revenue. Employee Shareholder Status (ESS) is an example of when things haven’t worked out. The understandably popular arrangement had to be scrapped, as the ability for tax free gains was used in unintended ways.

However, successive governments have been open to consultation and have tried to support and encourage employee ownership, and we have seen some helpful legislative changes to facilitate demand. There was a drive around 2010 from the industry to reform and provide more opportunity for equity based incentives – sometimes in subtle ways, but ways that have been helpful to allowing entrepreneurs to give equity in a more tax-effective way.

These schemes fall into two broad categories: those that deliver shares and equity immediately, and those where employees receive them in the future under an “option” arrangement. The former helps to provide more immediate alignment with management while the latter is more forward looking – it’s a promise that if certain things happen, employees will receive equity. Under these circumstances, it’s important for both sides to think about exactly when the value can be realised. It shouldn’t just be a dangling carrot that’s always out of reach; and it should be tied to the success of the company.

Within the options world, the Enterprise Management Incentive (EMI) is the most widely used plan for small and medium-sized businesses. It allows entrepreneurs running companies with assets of £30m or less to let employees buy shares of up to £250,000, without paying Income Tax or National Insurance on the difference between what they pay for the shares and what they’re actually worth when they buy them. The shares are subject to Capital Gains Tax, rather than Income Tax, at rates as low as 10 per cent.

Some founders think an employee-owned business provides the most appropriate framework to drive the right culture, engagement, and performance, and will operate this in conjunction with the government-backed Employee Ownership Trust (EOT). An EOT has the added benefits of being able to pay tax free bonuses of up to £3,600 each year to employees and of founder shareholders being able to sell their equity into an EOT free of tax.

There are very important commercial aspects that entrepreneurs must consider when designing a scheme. It’s not just about the company achieving a big target in the future, it’s also about personal targets – how to link an equity programme to how individuals are performing so it can be translated into a three-year (or longer) timetable for the firm. There’s also the issue of what happens if the employee leaves. Do they lose everything? For a founder, allowing yourself flexibility and discretion is key, so you can react to decisions based on different circumstances and protect the company. For employees, it’s important to understand the likelihood and hurdles until these incentives are realised.