The latest FSB Small Business Index Report makes gloomy reading, highlighting the twin challenges SMEs are facing: rapid inflation and labour shortages. The challenge of attracting and retaining staff is acute, yet many small companies have to keep a lid on costs and cannot necessarily pay top dollar to keep employees on side. What else can they do to attract, retain and motive employees in this very difficult climate?
Share ownership may provide an alternative (or complimentary) way for employers to meet those objectives. Issuing shares directly to key employees is relatively straightforward, but is not without major drawbacks; normally the employees will suffer income tax on the value of the shares received (less any amount they contribute), which they may not expect and may not have the cash to fund; and of course existing shareholders may be 'diluted' as a result of the new issue. So it pays to look at alternatives.
It may be possible to reward employees through one of the tax-advantaged share schemes that we have in the UK; the Enterprise Management Incentive (EMI) scheme is very popular in this regard. Under an EMI scheme, employees are not usually required to pay any tax until they exercise their options (which typically happens only when the business is sold); at that point, they pay Capital Gains Tax on the gain, potentially at a rate as low as 10% with the benefit of Business Asset Disposal Relief. It is also possible to structure EMI schemes so that the options can be exercised at other times (i.e. not conditional on a sale of the business), and objective performance criteria and objectives can be set so that the options can only be exercised where those objectives are met.
Not all companies (or employees) qualify for the EMI scheme, however. An unapproved share option scheme may be appropriate in those circumstances, which does not share the same tax advantages but may still deliver benefit for the company and employees.
Growth shares may offer another route to reward and incentivise key employees. Growth shares are a special class of share which enables the holder to participate in the growth of a company from the point of issue (creating an economic 'hurdle'). The hurdle is normally set at a level somewhat above the current value, to limit the risk of the recipient having to pay any income tax on receipt of the shares. Provided growth shares are structured correctly, with the recipients paying full value for them, there is no income tax or NIC at the point of issue. Capital gains tax would of course be paid by the shareholder following a sale. Growth shares also offer a way to prevent existing shareholders being diluted, since the holder only participates in any growth in value from the point of issue.
Share incentive schemes such as those discussed above can be a great way to motivate employees across all levels of an organisation, but it is crucial for any scheme to be properly established and communicated to employees in the right way. For the founders/ owners, there will often be a trade-off between giving up some of their equity; but in return, hopefully, delivering improved productivity and staff retention. Owners need to ensure that employees have a sound appreciation of the business strategy and, if appropriate, its exit strategy, since if they do not understand these aspects, they are less likely to understand or appreciate the value of the share incentives - and therefore the scheme may not deliver the expected benefits.
Implementing share incentive schemes can be complex and it is always important to seek professional advice to avoid problems. In particular, mistakes in setting up plans can lead to unexpected (and very unwelcome) tax charges. Employees may have lots of questions about how a scheme works and what should happen if they leave the company before any options are exercised. Professional advisers can help you navigate these issues successfully.
Properly executed and communicated, a share incentive scheme can represent a powerful way to motivate and retain employees, even in the current climate. Contact us today to find out more.