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Which equity incentive plan is right for my business? – Part 3
3rd Sep 2020
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Which equity incentive plan is right for my business? – Part 3 - Linkilaw Solicitors
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Choosing The Right Equity Incentive Plan

Introduction

This post is the last in a 3-part series regarding choosing the right equity incentive plan for your business.

In our first post in the series, we explained the concept of equity incentives and why companies choose to offer them. We reviewed the difference between shares and options, as well as the difference between approved and unapproved plans. Lastly, we reviewed five common share incentive plans in the UK: Share Incentive Plans (“SIPs”); Share Vesting Plans; Growth Share Plans; Restricted Stock Unit Plans (“RSUs”); and Phantom Share Plans.

In our second post in the series, we focused on option plans, reviewing the four main types of option incentives available in the UK: Standard Options; Enterprise Management Incentive (“EMI”) Schemes; Company Share Option Plans (“CSOPs”); and Save As You Earn (“SAYE”) schemes.

In this post, we will compare and contrast the various types of share and option plans available to help you determine which type of equity incentive plan is right for your business

How do I determine which equity incentive plan is right for my business?

The analysis required to determine which type of equity incentive plan is right for you can be broken down into the following four steps:

  1. Understand what you are trying to achieve.
  2. Determine which schemes your company qualifies for.
  3. Weigh the financial implications of the remaining plans against the resources needed to implement and maintain the plan.
  4. Evaluate which of the remaining schemes align with the goals you identified.

Understand what you are trying to achieve.

The first question to ask yourself when evaluating which equity incentive plan to choose is why you are considering offering an equity incentive plan in the first place. Many companies base their decision solely on financial considerations, without determining whether the most tax-advantaged plan they qualify for will truly achieve their goal: to incentivize certain people to take certain actions.

Defining the underlying reasons for your equity incentive plan involves asking yourself the following questions: Who are we trying to incentivize? What are they motivated by? What action are we incentivizing them to take? Why do we need an additional incentive for them to take that action? How will the right equity plan incentivize them to take that action?

Determine which schemes your company qualifies for.

Once you have an understanding of what you would like your incentive plan to achieve, it is time to begin narrowing down your choices. The best way to begin this process is by gathering the relevant information to determine which tax-advantaged schemes your company qualifies for, and eliminating any schemes for which your company does not meet the criteria. The information relevant to this step includes:

    1. The industry your company is in, including which industry codes are listed in your company records with Companies House;
    2. Whether your company is legally considered to be part of a group of companies;
    3. Whether your company is listed on a recognised stock exchange;
    4. Whether your company is legally considered to be under the control of another company, and, if so, whether that company is listed on a recognised stock exchange;
    5. How many employees your company (or group of companies, if applicable) has;
    6. The value of the gross assets of your company (or group of companies, if applicable); and
    7. The type of shares you intend to offer through the incentive plan, including share class, whether the shares are paid or unpaid, whether the shares are redeemable or non-redeemable, the market value of the shares, and whether the shares are listed on a recognised stock exchange (if applicable).

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Weigh the financial implications of the remaining plans against the resources needed to implement and maintain the plan.

One of the most important factors – and often the deciding factor – in choosing an incentive plan is the tax advantage. It is important to know what tax advantages (or disadvantages) your company would receive from each plan, and to calculate the effect those advantages would have on your bottom line.

However, to determine the true net financial effect of implementing an incentive plan, you must also evaluate the amount of resources needed to implement and maintain the plan. Resources needed for implementation include the time and money needed to set up or prepare an HMRC application for the plan, which often includes engaging an accountant or a lawyer. Also consider the time and money required to maintain legal compliance with each plan on an annual basis.

In addition to the financial implications for your company, it is also important to consider the financial implications the plan would have for your employees. Most tax-advantaged plans offer advantages for employers and employees alike, and the greater the tax advantage for the employee, the more motivating the plan will be. On the other hand, if the financial implications of the plan prohibit the employee from enjoying the incentive in full, the value of that incentive plan decreases.

Evaluate which of the remaining schemes align with the goals you identified.

Consider how the remaining schemes operate and whether the features of those schemes align with the goals you identified. For example, whether you would like to implement the scheme company-wide versus for a select employee or employees affects whether to choose a discretionary or non-discretionary scheme. Similarly, which aspects of an equity incentive will motivate the employees you intend to offer it to will affect whether to choose a plan in which the benefit is mainly financial, versus a plan which gives the employee voting rights.

The timeframe in which you need the employee to take the incentivized action is also a factor. For example, if losing the employee before a certain milestone is achieved will have a major impact on your business, a plan in which the financial benefit is not realised until an exit may not be advisable.

It is also important to understand why this additional incentive is needed on top of the employee’s current compensation package – after all, an incentive scheme is only one component of an employee’s overall compensation. The type of incentive that is appropriate to make up for a lower-than-market-rate salary differs greatly from the type of incentive that is appropriate to motivate fast company growth.

Conclusion

Choosing the right equity incentive plan for your company requires understanding and evaluating a number of factors.

Before you begin to evaluate equity incentive plans, it is important to understand the types of plans available in the UK, as well as how each type of plan operates. Once you have an understanding of the options available, you will be equipped to evaluate the factual considerations, such as which schemes your company qualifies for, the financial implications of various plans, and the resources required to implement and maintain each plan.

Although these factual considerations are important factors in your decision, it is equally important to understand what you are trying to achieve with your incentive plan and what the plan needs to be able to do to achieve your goals. An equity incentive plan is only one piece of an employee’s overall compensation. As with any business decision, finding the right solution requires not just details, but big-picture context.

Book a call with our team today for more information.

Our legal commentary is not intended to be a comprehensive review of all developments in the law and practice. Please seek legal advice before applying it to specific issues or transactions.

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