Option schemes, you could be wasting your money

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So I will admit, the title was supposed to get your attention. But there is truth in it.

An option scheme seems like the kind of thing that all good conscientious owner-mangers should put in place. It will attract talent, endear loyalty, drive alignment in behaviours and increase the value of the resultant equity in the owner-managers hands – right?

Well possibly, but not without an exit plan fully articulated to the holders of the options. Otherwise they are meaningless bits of paper. It always surprises me how many options schemes we come across where the participants have no idea what the chances are of their paper turning to cash. As such it shouldn’t come as a surprise that these employees don’t value the scheme and it makes no difference to their performance and the owner-manger resents having put it in place with little ability to reverse the decision. Therefore, a significant waste of money, even before we consider the professional fees to establish the scheme in the first place.

There are ways to structure schemes so that internal markets are created or, after a qualifying period (say – 5 years) the options become exercisable and the option holder can become a shareholder with entitlement to dividends. However, most owner-managers are more comfortable with an exit only scheme that will not confuse the cap table, interfere with their tax planning for profit extraction or result in demands on cash to buy back shares at inconvenient times. It is these exit only schemes that I focus on here.

The good news, is that properly used option schemes and in particular EMI (Enterprise Management Incentive) schemes can be highly effective. The EMI scheme has the added benefit of being highly tax efficient, allowing materially all of the reward to be taxed to capital gains, rather than income. Under the right circumstances, entrepreneurs relief can also be achieved so the employee pays as little as 10% tax.

However, focusing on these tax benefits, as many advisors do, is missing the point.

Regardless of tax, an option scheme pays to an employee on a per share basis exactly the same (gross) as the owner-manger, as such maximising the price per share brings about a common cause. This can be used to the owner-mangers advantage, but only if the employee is sufficiently clear about the exit plans and the levers that need to be pulled to maximise value.

It won’t surprise you that here we can help. You require not only a clear strategy, but an exit plan and a clear commitment to deliver it – alongside the now incentivised team.

Further, we can make sure, on the basis of your personal value aspirations for the business, that the options are set at the right levels, bringing the focus on monetary returns rather than emotive percentages – which are meaningless out of context.

I’ll accept that some owner-mangers use option schemes to widely reward employees for loyalty or length of service and this is a personal choice. But if the aim of putting in your option scheme is to drive your business forward, its only half the story.

If you’d like to speak to us about building a scheme for you, please get in touch, we’d be happy to help.