Should you replace your bonus scheme with an employee share scheme?

So you want to reward employees for hitting their targets. You might be thinking that a cash bonus scheme is the best option. After all, it’s the tried and tested way. But have you thought about sharing equity instead? 

We know that employee share schemes have a positive impact on productivity and retention.

• HM Treasury research found that tax-advantaged employee share plans increase company productivity by 2.5% to 4.1%.
• And 95% of our customers said that their EMI scheme has actively helped to improve employee loyalty. 

But that’s not all. Most know by now that employee engagement is crucial to business success. A report by Gallup found that the most successful organisations put employee engagement at the heart of their business strategy.

And if there’s one thing that share incentives do, it’s increase engagement. Why? Because when an employee has shares or options, they’re more inclined to contribute to the company’s success. We call this the Ownership Effect.

Once a cash bonus is paid, that’s that. They’ve crossed the finish line, but now what? Is the plan to keep dishing out bonuses? You want to keep employees engaged for the duration they are with you. And if you’re relying on bonuses alone to do that, it could be costly. 

Especially if you own a startup and don’t have the budget established businesses do.

With option schemes like EMI (Enterprise Management Incentive), employees become option holders with the opportunity (but not the obligation) to become shareholders in the future.

And by that point, the shares could have considerably increased in value which could be far more financially rewarding than a one-time cash payout. 

Alternatively, Growth Shares schemes offer the best of both worlds; shares and cash rewards in the form of dividends. Both EMI options and Growth Shares can be conditional, so the release of equity is tied to performance. (We’ll explore both in more detail later).

There's also a theory that bonus schemes can have an adverse effect; instead of feeling motivated when someone dangles a big bonus, a person may feel overly controlled and therefore reluctant to meet expectations, especially in highly competitive environments. 

Shared ownership, on the other hand, fosters a sense of camaraderie. Team members are more likely to work together well to ensure the future success of the business. They're all in it together.

Not only that, but countless companies are still recovering from the impact of Covid-19. So, it may not be possible to pay hardworking employees a lump sum right now or in the next 12 months. 

By offering a share or option scheme, employees can still feel valued while you preserve cash flow. And in the case of EMIs, there’s nothing to pay when granting options.

These are just a few reasons why you might want to set up a share scheme rather than a bonus scheme. Let’s take a closer look at the most popular share/option schemes with SMEs to help you determine which could be right for your business.

Bonus v EMI

EMI is a government-backed share option scheme specially designed with SMEs in mind. In 2018-19, around 12,400 companies had an EMI scheme in place. One of the main reasons is because EMIs offer huge tax advantages for both employer and employee.

Traditional company bonuses incur Income Tax and National Insurance at the usual rates, whereas recipients of EMIs pay just 10% CGT on any gains when the shares are sold. The table below outlines the tax efficiency of EMI in comparison to other schemes.

*Note: Entrepreneurs' Relief is now called Business Asset Disposal Relief.

Some will argue that investing in a bonus scheme is less risky than giving away equity.

However, if you design a share scheme well, you can mitigate the risk to existing shareholders; you can impose conditions for option holders to meet before any equity is released. They could be performance-based or time-based conditions.

For instance, you could set up a four-year vesting schedule with a one-year cliff. The employee must stick around for the duration before they receive their full allocation of equity. And a ‘one-year cliff’ means that 12 months must have gone by before any options vest at all. 

You do need to keep your scheme compliant though. As EMI is a government-backed scheme, Companies House require annual notifications and valuations. With a digital equity management platform like Vestd, that process is straightforward. 

Not every company qualifies for EMI, but that's fine. There are other attractive alternatives, like Growth Shares.

Bonus v Growth Shares

Unlike EMI options, Growth Shares are real shares issued almost immediately (providing that the recipient has to agree to conditions outlined by you). Only once those conditions are met (and awarded to a share class) can they receive dividends.

And if recipients never meet those conditions, the allocated shares can become deferred shares (worthless).

We use the word recipient here because Growth Shares can be issued to non-employees, enabling anyone contributing to the success of the business to share in that success. Growth Shares are more flexible than EMI options in that respect, with fewer restrictions. 

Recipients don’t have to pay Income Tax on exercise either, only Capital Gains Tax on sale.

Because Growth Shares are conditional and recipients can receive dividends, the scheme has parallels with a conventional employee bonus structure. But with the added benefit of the Ownership Effect!

Other Share Schemes

There are other alternatives such as Unapproved Option schemes and Agile Partnerships, which may be better suited to your business needs. 

Unapproved Option schemes aren’t as tax efficient as a HMRC-approved EMI scheme, but like Growth Shares, offer greater flexibility with fewer formalities.

With an Unapproved Option scheme, employees, advisors, contractors and consultants all get a slice of the pie. And you can stipulate performance-based conditions before equity is released to give you peace of mind.

Our Agile Partnerships™ framework was devised to help business owners release (and reward) equity proportionate to what people contribute. And conditions can be changed later down the line depending on the needs of the business at that time. 

Book a free consultation today and tell us how and why you want to reward your teams. We’ll recommend the best share or option scheme for you.

So a bonus is not the only way to compete for talent and motivate teams. Other incentives, like employee share and share option schemes, offer benefits to boot!

Of course, there's an education piece here. Most employees will know how bonuses work. But not all employees are clued up on the benefits of share and share option schemes. If you have any suggestions for how we could help, let us know in the comments.

The original article first appeared on the Vestd blog.