Granting equity to your senior management can be a powerful tool for aligning interests, incentivising performance, and attracting top talent in a small company.
But, as you might imagine, it’s complicated and it’s crucial to approach this decision strategically and legally.
Before diving into the specifics, it’s essential to grasp the key equity instruments commonly used in the UK:
- Ordinary Shares: Represent ownership in the company, conferring voting rights and the potential for future capital gains.
- Employee Share Ownership Plans (ESOPs): These plans allow employees to acquire shares in the company, often at a discounted price or through performance-based awards.
- Share Options: Grant the right to purchase shares at a predetermined price (strike price) in the future.
Once you’ve grasped that, there’s a number of key considerations. Firstly, and perhaps most obvious, you’ll need to get a formal and fair judgement of the market value of your company’s shares. One way is a 409A valuation which, while not strictly required in the UK, it can provide a reliable estimate of fair market value.
And there are, of course, tax implications for both the company and employees. There may be capital gains tax liability for individuals when they sell their shares, and there may also implications for national insurance contributions.
Remember too, the legal and regulatory framework: you have to adhere to the Companies Act (2006), with HMRC regulations around share schemes and with employee rights legislation, especially that which ensure fair treatment for all who work for you.
And when working out who gets what, in equity terms, make sure you’ve established clear and measurable performance targets linked to the granting of equity, and regular reviews to assess progress and adjust incentives.
You’ll also need to understand vesting conditions:
- Time-Based Vesting: Shares vest over a specific period, such as four years, with a one-year cliff.
- Performance-Based Vesting: Vesting is tied to the achievement of specific performance goals.
And make sure it’s all clear: communicate openly with senior management about the equity grant programme, create a written agreement that outlines the terms and conditions of the grant and provide regular updates on the company’s performance and the value of the equity.
You’ll also need a plan for an exit strategy:
- Liquidity Event: Consider how equity will be cashed out, such as through a sale of the company or an IPO.
- Buyback Provisions: Establish a buyback policy to allow the company to repurchase shares from departing employees.
It’s a complex process but can incentivise and reward your key talent, but, whatever you do, take advice from our expert team. Get in touch and we can help you build the equity structures to drive you to ever greater success.
