How are employee share schemes allocated?How are employee share schemes allocated?

First, an introduction to ESS

Employee share scheme (ESS) is the umbrella term for a few different types of scheme that a company can offer their employees.

For example, an options scheme offers employees equity, in the form of options, which can benefit both the employee, as well as start-ups and high-growth companies if the company grows in value over time. There are also more profit-based schemes that can have significant benefits for employees in profitable, private businesses. These include loan-to-purchase schemes, phantom or bonus shares, and managed buy-outs. 

These employee equity plans can be offered to all employees or key employees only. It is a process that a company can choose to go through to offer equity in the form of formal equity (shares) or profit-sharing to an employee (or contractor) over a period of time.

Understanding how employee profit-sharing works offers an appealing way to introduce long-term incentives without immediately drawing cash out of business.

What benefits do ESSs have for key employees?

ESSs offer staff the chance to invest in a company and potentially earn significant returns, typically without having to find the money to make a sizeable lump sum payment upfront.

Research shows that employee-owned businesses, on average, perform better than more traditionally-owned businesses. This is understandable because when increasing employee engagement through ESSs, staff are given a sense of ownership in the company they work for. Staff allocated share ownership from their employers report higher job satisfaction and motivation. Some companies offer shares to employees throughout the company so that they don’t simply benefit a select few for this reason.

What’s in it for employers?

ESSs form a strong tie between a company and its employees when staff can purchase shares in the company at a set, often competitive, cost. Some benefits to the employer include the following:

• Enhancing employee retention

• Boosting workplace culture & job satisfaction

• Increasing productivity & profitability

• Maintaining customer loyalty through improved service

According to Gallup, a global analytics and advice firm, businesses that scored the highest on employee engagement showed 21% higher levels of profitability than units in the lowest quartile. Companies with highly engaged workforces also scored 17% higher on productivity.

Given organisations with the most engaged employees experience more productivity and higher customer engagement, the benefits of ESSs can soon outweigh the costs of creating and managing such a scheme.

Where do you start?

Create a realistic equity plan

Step one of setting up an ESS is deciding on your plan objectives, like creating an ownership mentality for employees or supporting retention goals.

Afterwards, the optimum type of ESS needs to be selected. Common ESSs, such as call option plans (often called employee share option plans (ESOPs)), loan-to-purchase schemes and phantom share schemes, can appeal to different companies depending on their size, structure and maturity.

Choose the best type of ESS for your company

Choose which type of ESS is right for your company and then talk to your professional advisors, such as lawyers or accountants, to ensure you select the best plan for your company.  These professional advisors will help you create the ESS documentation and ensure legal compliance with your constitution, any shareholders’ agreement and the Financial Markets Conduct Act 2013.

After deciding on an approach, an ESS pool (number of shares available to employees) can be allocated. The pool typically sits around 5–15% of the total shares in the company. Decision makers can model how much to grant to employees and how that would affect (dilute) existing shareholders.

Factors that affect ESS allocation

There are several factors to consider, depending on your objective, when deciding how to allocate shares to employees, including the following.

Size of the ESS pool

Each option pool should have the goal of setting aside enough equity to retain and hire the people your company needs before the next round of funding. So, a company should plan for who they are hiring and how much allocated stock they would need to award them.

Employee’s seniority and job function

Once an ESS pool has been created, a company can select which employees to invite to participate in the scheme. Some companies reserve allocations for top-tier positions, while others opt to give all their employees some equity.

The stage of the company

The skill sets of the current staff will also influence the number of shares to employees. A smaller option pool for additional staff may be needed if there is a good team with existing equity. However, if the need for growth requires the company to hire many employees, a bigger pool than a standard 10% pool may be necessary.

Process of allocating ESS shares

When the time comes to allocate ESS shares with your staff, there are three main steps.

Identify a tier allocation for different levels

Ideally, you want three or four clearly defined tiers to determine the allocation of shares, where every employee understands which tier they fall into, and there isn’t a case-by-case negotiation. This saves admin time while keeping things fair and transparent.

Invite participants to the scheme

Once an ESS pool has been created, companies can decide which employees to invite to participate in the scheme. Some companies reserve allocations for top-tier positions, while others opt to give all their employees some equity. As a general guide, employees at the same level should be offered the same range of shares.

Build in a buffer

Your hiring plan may change. You may need to offer a bigger signing bonus than anticipated. There are many reasons you should include a buffer in your ESS pool. The buffer can be a manageable size but should allow you some room for manoeuvre—1–2% is usually enough.

In summary

ESSs benefit employers and employees, encouraging more significant effort and commitment in exchange for financial compensation. Although, they’re not always simple and can cause frustration if the employee doesn’t fully understand the terms of their plan.

Not all ESSs are the same. Rules on actions such as vesting and withdrawals can vary, and it’s essential to be aware of them when equity management software for your company.

For help in making the right choice for your company, contact Sharesies today.