Everything you need to know about tech start-up share options

With a significant number of high-growth tech companies choosing to rebalance their pay packages in favour of options and other employee share awards, Claire Matthews explores the benefits

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Under increased pressure to manage cashflow, limit costs and battle inflation outstripping potential salary increases, businesses see share options as critical to winning and retaining key talent in today's competitive labour market.

What are the benefits for your employees?

Option prices and grant sizes are typically more attractive at lower share valuations, meaning employees can stand to make windfall gains. In the listed environment, the Investment Association and other institutional investors continue to put pressure on companies to scale back grants after a substantial fall in share price. However, for their cash-strapped start-up counterparts, this may be the only boost to pay packages they can afford.

Employees can also stand to make tax savings. In the UK, tax-favoured plans include enterprise management incentives (EMI) targeted at small, higher-risk trading companies with assets of £30m or less and fewer than 250 employees. EMI options give employees the right to buy shares in future and, provided the price they pay is at or above the market value of the shares on grant, any increase in value is free of income tax and national insurance contributions (NIC). Instead, gains are subject to capital gains tax, usually at lower rates than income tax, and rates may be reduced further if business asset disposal relief is available.

EMI plans have increased in popularity year on year and are the largest contributor to income tax and NIC relief of all UK tax-favoured employee share plans. Recently announced changes for UK tax-favoured company share option plans will also widen access to these plans for more growth companies from April 2023.

Other popular share incentives include growth shares and joint share ownership plans (JSOPs), which entitle employees to returns above a hurdle set above the current value. These highly leveraged structures usually require upfront subscription and only deliver value above the hurdle, but that value is then normally subject to capital gains tax rather than income tax and NIC.

Benefits may be optimised if awards are granted when the company's valuation is low, but crucially this must be followed by a period of growth to deliver value to employees, with growth shares and JSOP awards only really appropriate for companies with strong growth expectations.

Looking to the future

To maximise impact, share plans should be designed to support the company's strategy over the medium to long term. As well as attracting and retaining employees, they should incentivise them to deliver corporate goals, supporting the creation of long-term shareholder value.

However, any ability to create long-term value will be eroded and benefits to employees will be lost on them if the incentives are not well understood. Effective communication is key and it can be helpful to provide employee-friendly materials alongside the legal documents, including an explanatory letter or booklet, tax guidance and worked examples. It is important to communicate the plan's purpose throughout, aligning the messaging with the business strategy.

Another area of focus for investors is dilution, and companies may need to come up with new ways of managing headroom issues. These range from restructuring options as share appreciation rights to use of a trust. For start-ups the simplest solutions are likely the best, particularly where there is no liquid market in the shares.

Investors may also push for increased company protections, particularly to avoid reward for failure if expected growth does not materialise or in the event of conduct issues, but the extent to which these protections are appropriate should be considered based on the plan and its objectives.

Fundamentally, share plans need to be fit for purpose and anticipate key legal and tax issues upfront. When managing a sale or internal reorganisation, the last thing businesses want to deal with is additional option plan administration and fallout from employees losing anticipated tax benefits. Using an off-the-shelf plan may appear to be a saving but can cause time-consuming and costly problems in the future. Firms should take appropriate advice when establishing the plan.

So, while the changing economic circumstances may present an opportunity to implement new share plans or top up award levels, it is crucial for businesses to have the right plans in place to support them, their investors and their people throughout the corporate lifecycle, to help navigate the challenges that lie ahead.

Claire Matthews is a partner in the tax and incentives team at Taylor Wessing