Employee Share Option Plans (ESOPs) can be a fantastically useful tool in the toolbox of founders and investors alike. Whether used to incentivise employees or management, they provide a way to provide an opportunity to take part in a future capital windfall.
This can be especially useful as a trade off against a lower salary or a way to secure and fill roles such as non-executive chairman if not simply to show how much the company appreciates the contributions of staff. We have been in regular contact with start-ups reviewing their salary structures and the advantages of deploying an ESOP to conserve cash.
At a time when businesses fight to survive in an economic landscape none of us could have imagined, any company will want to protect its core assets and I would argue these assets are a company’s people. A recent study conducted by Oxford, LSE and MIT researchersfound a high correlation between employee wellbeing and satisfaction with firm performance. Significant research has been carried out in the United States in this field and the link between ESOPs and increased firm performance. One such paper notes ESOPs generating a positive outcome from employees in terms of company performance. Whilst ESOPs are not the be-all and end-all, at a time when companies look to secure survival, ensuring staff are happy and incentivised would seem to be a smart move.
In light of the COVID-19 lockdown, companies will be well advised to take stock of their toolbox and look at the possible benefits of putting in place an ESOP now and in particular an EMI tax-incentivised plan.
Valuation during the Pandemic
There are very few aspects of life that have not been touched by the global response to COVID-19. Supply chains face unprecedented disruption and businesses face suppressed revenues and cashflow seeing a reduction on valuations. But alas, amidst the storm clouds there may be a silver lining.
EMI Options are a form of option which attract tax reliefs for both the employee receiving the option and for the company granting it. To safeguard the reliefs, companies will almost always obtain an approved share valuation from HMRC and this forms the option price (the price which the employee pays for shares on exercise of the option). Given the current climate of reduced valuations, there is unlikely to be a better opportunity for more mature companies to obtain a significantly reduced valuation for the purposes of granting EMI options, giving staff under the ESOP a greater exposure to growth in value.
Performance Criteria and Incentive
The research mentioned indicates that broad based ESOPs don’t have the same impact as those with clear performance incentives. A broad-based ESOP would be one applied against all general staff and under which option awards are earned based on time in service. The broader the scheme the less mitigation of “tail-riders” and the weaker the link between employee individual contribution and impact on company performance. That is not to say that a broad based ESOP does not have a positive outcome but the more specific the incentive is the more likely the company will see greater employee impact. For this reason, staff should be incentivised specifically and that their contribution has an impact on company performance. In some cases as part of keeping employeeshappywe are seeing options being granted as a thank you for specific Covid-19 salary sacrifices being agreed. We can assist founder teams and investors with review and preparation of appropriate conditions and hurdles in ESOPs to ensure that the company’s option documents are tailored to get the most out of employees.
Setting expectations out clearly is a good way to avoid acrimony later. Option agreements should be clear on what happens if an employee leaves the company and whether it will mean the entire option lapses or whether they can keep part of it. Are you clear on the lapse provisions of your ESOP? Are your staff? Are they still appropriate for the current economic landscape? For example, have you included leaver provisions that allow for critical illness?
ESOPs set up so that options can be exercised before an Exit will mean that the optionholders in those cases may become shareholders. It will be important for companies to reassess the leaver provisions in their articles of association to ensure that the current climate does not create issues for those staff exercising options. For example, if you are having to ask your staff to take prolonged Covid-19 salary sacrifices then loyalty can start to wither on the vine. Many staff may soon look to leave once the job market eventually returns and being able to recycle the option shares that they have purchased from vested options could be very important.
Our dedicated options team and Holistic HR team can provide a rounded discussion with you on how to structure your incentive schemes, whether by ESOP, bonus or wellbeing programmes, helping you ensure your people are happy people and that your company stands the best chance of weathering the Pandemic storm.
(although the paper focused on traded companies in the US, the principle of employee buy-in is similar as to that of a private limited company) Broad-Based Employee Stock Ownership: Motives and Outcomes, E. HAN KIM and PAIGE OUIMET, 2014