3 important ways to retain your best people

Share options are when you give someone who works for you a certain number of shares in the business. They are priced at today’s valuation though the employee doesn’t have to pay for them just yet.

What you hope is that the share price increases as the business prospers because when the vesting period is up, your employee can buy their shares at the original lower price, and sell them at a profit.

So, Daniel B is a software engineer at tech start-up ABC. Jennifer, the founder of the company, gives Daniel 10,000 shares, which are valued at £5 each. Daniel is allowed to vest 25% of his shares after one year, 50% after two years, 75% after three years and the full 1,000 after four years.

After one year, the shares are valued at £7.50 so Daniel can now sell 2,500 shares making a profit of £6,250. After two years, the company is doing spectacularly well and Daniel can now sell another 2,500 shares (or 5,000 if he has been patient). The share price is fixed at £12.00 so Daniel is making a profit of £7 per share. He could cash in for £35,000.

While Daniel was not taxed when he was granted the 1,000 shares, he is now going to have to pay income tax and an NI contribution which could add up to a tax rate as high as 53.4%. It’s possible he nets just £16,310.

An Enterprise Management Incentive, to give it its full name, is a scheme designed for small businesses. EMI options cannot be awarded in a business worth over £30 million or with more than 250 employees. From a tax perspective, they are considerably more generous than ordinary share options. They are taxed under CGT (Capital Gains Tax) which is lower than income tax and they qualify for Business Asset Disposal Relief (if the employee is still with the company at the time of sale).

If Jennifer had set up an EMI scheme, Daniel would have had to wait until the company was sold. The reward for his patience is that he would pay a lot less tax.

For the employer, the attraction is a Corporation Tax deduction for the profit made by the employee. However, there are restrictions. And the value of the shares and options has to be agreed with HMRC before you start distributing them.

If you want to know more about the pros and cons of EMI options, give us a call.

Let’s say your business has been performing well. You bring in a sales director to help you grow even faster. This is not someone who has been with you from the beginning. On the other hand, you want to encourage them to know that if they make a difference it will be rewarded.

You can award the newcomer with shares which are valued at a ‘hurdle’ price. You can also pay them dividends, which you can’t do with options.

For example, Daniel joins WowTech as their IT Director. He is given 5% of the growth shares issued. The company is worth £10 million and a ‘hurdle’ valuation is set at £12 million. If the company grows to £30 million, then he will share in 5% of the £18 million increase.

Growth shares are good for businesses that are already doing well. They encourage employees to give 100% by getting them to think like co-owners of the business. And they aren’t subject to Income Tax.

Each of the reward schemes we’ve described has its advantages and disadvantages. We can explain them clearly. More importantly, we can help you avoid some of the mistakes people often make, albeit with the best intentions.

You really don’t want any shareholder disputes as and when you come to sell the company. The more thought you put in at the beginning, the easier it will be at the end.