How attractive are share schemes for startups?

If you’re tempted to join a start-up company it’s likely that a big incentive will probably be the stock options that come with the typical benefits package offered by start-ups - the opportunity to own part of the business. But, if you leave the business, how easy is it to exercise those options? Is it an incentive that really only works for higher-paid senior executives?  

That is the claim in an article that has appeared on Personnel Today’s website. In ‘Why equity isn’t equitable when it comes to working for start-ups’ they say: ‘The bottom line is, if you’re unable to come up with the money to exercise your options, you’ll miss out on the potential for financial gains from your hard work.’ The argument is that it’s unfair and that more employees should be able to purchase their options.’

So, let’s consider that. James Sullivan-Tailyour is a share plans specialist and earlier he joined me by video-link to discuss the pros and cons of options like this. I asked James if he’d seen the article:

James Sullivan Tailyour: “Well, I did see that article and I’m not entirely sure I agree with the premise of it. I think perhaps it's coming at it from the angle that share options might be exercised at a point prior to an exit, such as the sale or a listing, and when there's no market for the shares that you have exercised your option over and, in that circumstance, there's no market for the shares, so you can't sell the shares to pay the exercise price and any tax that's due on exercise but, certainly in a UK context, that isn't the way in which share option schemes are typically established. Often because the company wants to align its employees with the interests of investors insofar as achieving an exit, it often sets its share option scheme up on something called ‘exit only’ terms, which basically means that the options can only be exercised, and shares acquired, if and when that sale, or that listing, occurs and, if you do that, if you make option holders wait until there is an exit, and there's a market for their shares, they'll always be in a position to sell shares and fund the exercise price. So, whilst I do recognise the broader point that's made that share options are often given to higher paid employees, (a) that doesn't necessarily need to be the case, and (b) there are ways in which you can structure your share options to mitigate the requirement to pay the exercise price and ensure that share options are always exercised at a point when shares can be sold so as to fund those liabilities.”

Joe Glavina: “Anything else, James?”

James Sullivan-Tailyour: “No, I don't think so other than to say that, as always, it's really important to make sure that you get all your ducks in a row, to move swiftly, particularly if you want to grant tax advantaged share option schemes. Don't leave it too late and too close to an exit because there are rules there are valuation points which will mean that you may lose some of the tax advantaged treatment. It is always good to get these things done at a relatively early stage, but it's an entirely standard approach companies to take, it isn't novel or unusual, and there are lots of people, including Pinsent Masons, who are there to help companies set up and run share option schemes.”

If you’re early-stage company looking to attract and incentivise employees but you can’t yet afford to offer them big salaries a possible solution might be an Enterprise Management Incentive option scheme. Shortly before the Christmas break James talked to this programme about EMI schemes and the tax advantages they bring. That’s: ‘EMI schemes a useful way for UK start-ups to incentivise staff’ and we’ve put a link to it in the transcript of this programme.

LINKS
- Link to HRNews programme: ‘EMI schemes a useful way for UK start-ups to incentivise staff’