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Five key decisions before you use employee share schemes

Averill Dickson | June 30, 2015
In tech hotspots such as Silicon Valley, employee option schemes are commonly used in high-growth companies to incentivise talented people. Here is a guide to find out whether this option is right for your company, and what are areas to watch out for.

My view is that businesses should consider offering participation to any talented employee that can help the company grow, and where participation will help to attract, incentivise, retain and reward that employee. If an employee is unlikely to have any effect on the growth of the company, or is unlikely to be incentivised from participation in the scheme, leave them out. Conversely, don't leave out a star employee just because they aren't in a management role. Be aware, though, that picking and choosing employees in this way can be divisive and lead to employees not selected for the scheme being demotivated.

3. What price?

Options are issued with an exercise price -- being the price that the employee must pay to acquire a share if and when he exercises an option. Generally this is set to reflect the value of the company at the time that the option is issued, so that the employee benefits from the growth after that date. You therefore need to work out a realistic valuation for your company now. Don't set the price too high - a so-called "underwater" option (where the value of the underlying share is less than the exercise price) provides very little in the way of incentive to employees.

4. What if my employees leave?

In order to not only attract staff, but also to retain them, you need to design the rules so that staff have to stay for a certain period of time before they can exercise their rights to buy shares. This is called "vesting". Some schemes vest in tranches over time (for example, 1/3rd per year), others vest in one hit after a certain period of employment. Most schemes also provide for early vesting if some form of exit event takes place (for example, a sale or IPO of the company).

Also, if people leave, say after three years, there's usually a period of time under which they have to exercise their rights. Generally you don't want lots of former employees out there who still have options to buy shares in the company.

5. What sort of shares should I offer?

Option schemes can be structured so that employees that exercise their options receive non-voting shares in the company. The rationale for doing this is to provide the financial benefit of share value growth to employees but without making the majority owner(s) subject to employees (and possible ex-employees) having a say in the running of the business. However, in doing so, you are saying to your employees that you don't value their opinions.

You are also removing one of the key non-financial benefits of an option scheme -- giving your employees a sense of ownership in the growth and success of your business. For these reasons, we favour granting options over voting shares.


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