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Share option schemes: how to incentivise your team - 06/11/17

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Employee share schemes can be an excellent way for start-ups and SMEs to attract, incentivise and gain the loyalty of key employees.  At Bailey Fisher’s latest CEO Dinner, discussion focused on how this kind of incentive can align your goals with that of the essential members of your team.

The guest speakers were serial technology entrepreneur and adviser Richard Baker; and Neil Pearson, Partner at Mills & Reeve, specialising in advising on all forms of employee incentives.  The dinner was hosted in partnership with Mills & Reeve and Grant Thornton.

Key points emerging from discussion:

1. Options are worth doing. They do work to incentivise employees. But only if the option plan is well thought through.

2. It’s never too early to get the stock options policy in place.  Starting to use options sooner rather than later will embed them into the culture of your
business (and maximise tax efficiency).

3. When introducing options, it is key to understand the motivation behind granting them, which might be any one or more of the following:

  • Recruitment
  • Encouraging loyalty
  • Reward
  • Driving towards exit
  • Creating a sense of ownership and responsibility amongst the workforce (the “John Lewis model”)

4. It is also key, even at an early stage, to think about how the options would play out on exit, and what that exit might look like. This triggered lively
discussion as to:

  • Whether vesting arrangements should be introduced and if so, over what period should this be – industry practice seems to have moved from 3 years to 4 years vesting.
  • When to allow options to vest on a takeover or IPO and, if so, what proportion of options should be vested.
  • Whether to “roll over” options into the buyer, on an exit, to encourage the option holders to stay in the business post-acquisition.
  • How best to apply performance conditions in the context of an exit.
  • How to treat option holders who leave before an exit.
  • When and how option holders might be offered any form of liquidity in the option shares – if option holders felt they could never realise their option shares for cash, the options may cease to incentivise employees.

5. Many founders who attract angel investment tend to suffer too much dilution by the time they hit a significant Series A round. It is important to optimise
runway and try and avoid significant dilution. Most VCs would like to see a founder still owning 30-40% of the business by the time they hit Series A.

6. Growth shares are becoming more popular and can be used to bridge the gap between the dilutive effect of options and the need to keep managers incentivised.  The estimate was that as much as 50% of new raises are including growth shares. Growth shares were defined as simply the grant of ordinary shares to founders, priced slightly “out of” a current round price that are linked to growth performance of the company. Investors are more willing to incentivise the founding team with growth shares rather that enlarging the stock options policy. Stock Option Policies seemed to have a natural ceiling at 15-20% of share capital.

7. Founders shouldn’t feel that stock options pricing needs to follow share price through investment round stages. An EIS approved stock options policy should try to retain nominal share price of £0.01p until the point of break-even and early profits. The UK HMRC will approve the majority of options policies
through to this point in time. This retains real upside value for founders and employees.

8. Innovation in private capital markets with the arrival of secondary market exchanges such as AssetMatch generates interesting opportunities for private limited companies to sell small percentages via these platforms. Joining such liquidity venues requires changes to the Company’s Articles of Association and will most likely need shareholder board approval but generating liquidity events for private companies has a number of benefits for founder and early seed investors. Shares can change hands, it establishes an enterprise value or market value for the company earlier in the development cycle than just waiting for the next investment round or indeed the trade sales. Additionally, it generates liquidity events for the stock options plan.

9. For some businesses, particularly quoted companies, using options to incentivise Non-Executive Directors was regarded as inappropriate.  NEDs are intended to act as an independent “watchdog” and this independence may be compromised by the share incentives.

It was encouraging to hear that talent in Cambridge is being attracted by realistic salaries and attractive options but also continues to be attracted by the opportunity to work with great people and on engaging projects.

CEOs attending commented on the “specific actionable insight” gained from the discussion, with the CEO of a VC backed company saying “A very important point for me was how to set the option price.  Previously, ‘last investment round price’ has been pushed upon me but that isn’t necessarily the way to go.  This will be very useful for me when discussing these matters with our Remuneration Committee.”

The CEO Dinner was hosted by Bailey Fisher Executive Search in partnership with Mills & Reeve and Grant Thornton.  If you are interested in finding out about future CEO Dinners, please contact Joe Graziano, Technology Partner at Bailey Fisher Executive Search.

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