Share Options and Employee Benefits

In this episode, I am joined by Sam Lenox, the Head of Employee Incentives at Harper James, a modern law firm, purpose-built to support entrepreneurial businesses in their growth from startup to scale up and beyond.

In this conversation, Sam and I explore the world of employee share options, looking at the structure, their implementation and an important insight for businesses who may be new to this world of incentives to better understand what is available.

🌟 Some of my favourite parts were:

✅ How to educate and manage expectations of young staff around share options;

✅ Understanding the not insignificant tax benefits of the EMI scheme;

✅ How an internal market typically works for these kinds of schemes;

✅ Managing Share Option schemes with an International hat on;

✅ Marrying long term ESOPs with shorter term bonus scheme.

 
Business Book Bonus Recommendation – 

Legacy – James Kerr - https://amzn.eu/d/5xTOA4B

Transcript

Adam (00:01.138)
So today I'm here with Sam Lennox, who is head of employee incentives at Harper James, a modern law firm, purpose-built to support entrepreneurial businesses in their growth from startup to scale up and beyond, according to the website. So Sam, welcome to the Fractional CFO Show. How are you doing?

Samantha Lenox (00:19.943)
Thank you, Adam. Really good and really pleased to be with you on the podcast this morning.

Adam (00:26.686)
Excellent, excellent. Well, great to have you here. And today we're diving into the world of employee share options, looking at the structure, the implementation and a bit of information for how to help businesses and their employees achieve their growth ambitions. So perhaps Sam, to start with, would you mind giving us a bit of an overview of your career so far?

Samantha Lenox (00:49.379)
Yes, of course. So I've been working in employee share schemes for over 20 years now, both in law firms and in accounting and consultancy firms. So, you know, this is an area which I have lots of experience in. And it's a fascinating area because it's always changing, there are new developments, which makes it interesting.

Yeah, so it's been a really good journey. I've joined Harper James recently to lead their team and you talked a little bit about the firm when you introduced me and it's, you know, share options for growth companies are sort of a huge part of their journey because it's about, you know, how do we align the interests of the shareholders with the workforce to achieve our shared ambitions and to, you know...

to participate in that journey collectively and the equity, the share options are part of that toolkit and how we achieve that. So really good to be in an environment where share options and incentives are a really important part of the offering that we deliver to clients.

Adam (02:05.97)
Excellent. Okay, great. And you mentioned about how for small businesses, it's important as an alignment tool. Most of the audience of this pod are typically going to be smaller businesses, kind of less than 100 staff, and most of them probably won't have employee share option plans in place. So can you give us a brief overview of employee share option schemes at a high level?

Samantha Lenox (02:13.369)
Yeah.

Samantha Lenox (02:32.403)
Yeah, so if you think about when you form a company, typically you'll have one or two founders and they will own all the equity in the company and then they might get in internal external investment from a VC for example and the VC will say well actually it's really important that you have an option pool and that you are

diluting your shareholding and giving up some of the equity for the benefit of your employees. So that might be in a VC scenario, might not be, it might be just that you and your founder hold all the equity but you think it's really important to again give up some of that equity value for the benefit of your staff so that your interests and their interests

are aligned and you're giving them financial participation in the growth that they create in the business and you're doing that through giving them shares or share options in the company.

Adam (03:38.358)
Okay, great. And you know, you talk there about sort of shares or share options. Could you perhaps just explain the difference between the two?

Samantha Lenox (03:44.151)
Yep, yeah absolutely. So a share option is a right to acquire a share at a future date. A share is an actual ownership interest on day one. So for many companies they might think well actually we don't want to give equity ownership to our employees or our workforce.

on day one because if we do first of all we're immediately diluting the equity value in the company and second we then need to think about how we manage that shareholder base because it's very simple when you've got two founders or one founder you can pass resolutions you can do things all the

Samantha Lenox (04:43.543)
individuals onto your share register, there's just a little bit more complexity and administration and thinking about what rights you want to give those people. Do you want to give them economic rights? Do you want to give them governance rights, so voting rights for example? Probably not. I mean the economic rights is sort of, you know, you're unlikely to be in a position where you're paying any value on your shares anyway because you probably don't have the reserves.

at the beginning you're not going to have the reserves to do that. So that's a future thing. So an option is good because it's deferring the actual economic ownership in the business to a later date.

Adam (05:25.322)
Okay, very clear. And in terms of the benefits of share options, you've touched on them already in terms of aligning interests and giving benefits at a later date. And, yeah, I know people talk about the positive impact on staff motivation and on staff retention of having these options, particularly for the reasons you've said. Is there...

I guess on the flip side, a risk of some unrealistic expectations where you've got, you know, young staff who don't fully understand that lead time that you've got around when you're going to get that benefit. And particularly, as you mentioned, private companies where there isn't a ready market to sell. How have you managed that with clients that you've worked with in the past?

Samantha Lenox (06:12.495)
Mm.

Samantha Lenox (06:18.615)
Yeah, I mean it's a good question because, you know, typically you might have staff who've worked in other environments where they've had share options and they have an expectation of having share options when they join the company and that can be a really attractive tool for recruitment like you've already talked about. But then clearly, you know, as an owner who is

giving this benefit to employees. You need to think very clearly about how employees can monetize that benefit and obviously if you're you know in a PLC you've got a ready market you can sell and trade shares. If you're in a private company there's no illiquidity or marketing event.

As a business, when you're setting this scheme up, you need to think very clearly about, you know, what are our corporate objectives? Are we thinking that we're going to exit this business in the next five years, for example? Because that exit will provide an opportunity for employees to monetise the value of that share option or that share that they've been awarded.

If you're not going to exit, and so for some businesses, particularly at the beginning, they'll have their business plan, their various milestones, but they might see the company as a long-term play. They don't necessarily want to flip it and do an exit in that time horizon. So in that circumstance, they also need to be thinking, okay, well, if we allow our employees to buy shares and get shares in our company.

you know, how are we going to make that real for them? And then there are additional considerations to think about in terms of, can we create some sort of internal market, which again is another consideration and adds, you know, does add more complexity to the structure of the scheme. But I suppose that the fundamental is that, you know, share reward can be very valuable in terms of.

Samantha Lenox (08:34.831)
you know, recognising service and performance. But as an employee, it's very important to understand how you will financially benefit from that reward at a future point in time in order to give it significance and value in the hands of the employee.

Adam (08:54.634)
Yeah, of course. And you talked a bit there about an internal market. So, how would that typically work? Could you just summarize broadly how an internal market would be recommended to work?

Samantha Lenox (08:59.409)
Yeah.

Samantha Lenox (09:07.019)
Yeah, I mean, as I said to you before, it is complex and sometimes companies will set up a trust, so an employee benefit trust, to facilitate that internal market. Because effectively, what you need to think about is you need to find buyers and sellers. So in a public market, that's what we have. We have people who are buying and selling and that's, you know, the liquidity for the shares. On an exit event,

there's a third party, be that private equity, be that trade who is buying your company and then you've got a market, you've got a buyer and a seller for the shares. We haven't got that external market. We're having to create internal buyers and sellers. And that might be, as I said, a trust that facilitates transactions between employees, for example. Or it might be that one of the shareholders, if you've, you know.

wants to buy the shares but those are the sorts of considerations. It's about identifying who the purchaser will be and setting up a structure to enable that.

Adam (10:14.142)
Yeah, of course. And I can see the complexities, as you say, where it's an external market, i.e. a publicly traded company, or there's an exit or some kind of event, there's a ready buyer. If there's neither of those two situations, then you're having to manufacture it, right?

Samantha Lenox (10:29.603)
Yeah, exactly, exactly. And then, and you'll have to think about, you know, what are the considerations for each of the parties, you know, as a purchaser of the shares, you know, what does, what's the significance of that transaction, you know, from a corporate and tax perspective in relation to that individual. So there are lots more sort of considerations to take into account in relation to these internal markets.

But notwithstanding that, if it's a long term play, as I said, not all businesses are set up to have a liquidity event in a short time horizon. So it is important to be thinking about and it might be you don't need an internal market. It might be that you decide actually come a certain time we will be in a position to pay dividends and that you'll provide.

Adam (10:56.65)
And I guess...

Samantha Lenox (11:21.067)
employees with dividends as a means of monetizing or you know achieving some financial reward from their investments.

Adam (11:31.262)
And I presume that the... you touched there on the long-term sort of point of view around share options. And I wonder, and I'm interested in your experience of how you've married that with shorter-term sort of motivating effects. So, for example, have you worked with clients where you've put in place share option plans, but you've also taken a view on whether there's bonuses or some other shorter-term financial motivation?

Samantha Lenox (11:56.337)
Yeah.

Yeah, absolutely. I think that's really important, isn't it? I mean, practically speaking, many companies implement these arrangements because, you know, to control cash flow. So because they're unable to pay market or salaries in competitors and certain that competitors would pay, they can't deliver short term bonuses, they'll reward employees with equity.

instead. So clearly when you're thinking about the structure of compensation you need to be thinking about cash flow and what's affordable to the business. Now you know in more mature companies yes you know you would be thinking about

components of pay and you'll be thinking about salary, you'll be thinking about bonus and you'll be thinking about equity but that's in a more mature business which has that, you know, has the sort of the profits to distribute and the or the you know value to distribute to those employees so it's sort of a longer term play but you're absolutely right I mean share options are typically are a longer term incentive so you know we typically see.

maybe a four-year vesting period, which is the period over which the instrument is earned. And then, you know, and there'll be a sort of a vesting schedule over that period. So it's not the same as a short-term incentive, a bonus which you might pay, you know, which is typically paid at the end of a year for achieving short-term performance objectives. And for the companies, it is a different kind of instrument.

Adam (13:34.282)
Yeah, absolutely. And one of the areas that I know when we've talked before, you've sort of highlighted to me, and again, maybe people are not so familiar with, is the tax advantages that you get through share options, which makes them sort of more cost effective, again, as a way to reward. Can you sort of explain how you can, how you support companies and employees from a tax...

implication perspective when it comes down to share options.

Samantha Lenox (14:08.995)
Yeah, absolutely. So as you say, there are really significant tax advantages to certain arrangements which provide benefits both to the employee and the employer. And in the UK, the most common tax advantage scheme for

SMEs is the Enterprise Management Incentive Scheme and that is a highly beneficial scheme because when structured correctly and subject to certain conditions the financial reward which is delivered through that scheme is taxed at a very attractive capital gains tax rate. So

potentially a 10% tax rate up to a threshold. And that should be compared to employment income, which is taxed up to 45% or 47% if you're a Scottish person. And then there's national insurance, usually on top of that. So for an individual at 2% is the marginal rate. And then obviously from a company perspective, where income is taxed as salary.

there's national insurance, there's also the employer national insurance cost, so a 13.8% national insurance cost for the employer. So that's how salary and if you pay a bonus, that's how that instrument that is taxed. And then you have in contrast the EMI share option scheme where you are delivering valuable benefits to employees through this structure and the financial benefit is taxed.

at a capital gains tax rate of 10% up to a threshold. So, you know, clearly highly, highly beneficial. And that's because the government wants to...

Samantha Lenox (16:14.075)
put in place incentives to enable small and medium enterprises to attract talent and to be competitive in the way that they attract talent. And also, you know, I mean, the war for talent is, you know, in some businesses, it's a global war for talent. And so if you think that in the UK, we're competing against Silicon Valley.

and the US market where salaries can be much higher. If you're competing against the likes of Microsoft or Google or one of these really big players, how do you compete in that war for talent? And one of the tools that UK companies have is the Enterprise Management Incentive Scheme, which allows this very valuable reward to be delivered in a very tax efficient manner.

Adam (17:07.422)
I get that's a really good point. And I think that the difference between your capital gains tax and being taxed on income, as you say, is, is huge. So a real, real benefit there for, for employees. One point you just mentioned there about the global war for talent, I guess, is something that growing companies need to consider, because as you're expanding potentially internationally, you've got the tax implications of the different regions that you're going into. So is that something that you've advised companies on as they expand?

Samantha Lenox (17:17.125)
Yeah.

Adam (17:36.566)
how to manage share option schemes with an international hat on.

Samantha Lenox (17:41.82)
Yeah, absolutely. So we do a lot of that work and I've done a lot of that work. So if you're exactly, if you're going to the US, if you're going to Europe, if you're going to Asia and you want to recruit or you want to move a senior hire, for example, to establish your business in that new jurisdiction, then usually or often equity will be a really important component.

of their package to relocate and it's really important in those circumstances to take into account what the laws are in that new jurisdiction because the so as an example the EMI scheme is a UK scheme it's for UK employees paying UK tax if I then send an individual your business sends an individual to the US they're then going to enter the US tax net.

and be subject to US taxes. So really important then to take local advice and we again can organise that to understand what the implications are of going into that new territory from a sort of legal perspective and from a tax perspective. And also, you know, there are in many countries, there are regimes to like the EMI scheme, you know.

enable small companies and sometimes bigger companies to pay employees to share options tax efficiently. So lots of countries do and increasingly, for example last week the German tax authorities, the German Bundesrat.

Bundestag have implemented a new regime or they're going to implement a new regime in Germany to make it much easier for them and much to reward employees and startups tax efficiently. So that's another example. We had a new regime in Portugal earlier in the year. So lots and lots of, you know, European countries are catching up with the UK.

Samantha Lenox (19:44.147)
The UK in my scheme has been in place for 20 years or so now, but we're seeing increasing numbers of other countries which are kind of recognising the importance to their economy of attracting these companies and enabling them to recruit talent locally through these types of arrangements.

Adam (20:05.51)
Interesting, and as you say, something that needs to definitely be carefully considered before you start sending staff overseas to ensure that they don't breach any local laws, right?

Samantha Lenox (20:16.879)
Yeah, exactly. And to make sure that you, you know, you optimize the position for the company and the employee to the extent possible. Obviously, I mean, obviously there's something about simplicity as well. So when companies do move overseas and they do grant equity on a broader basis, you know, one of the guiding principles will also be to keep things as simple as possible.

and the quid pro quo with the tax benefits available in different regimes is usually there are criteria attached to those so for many companies you know actually administering a tax efficient scheme in a different jurisdiction.

can create more complexity and isn't necessarily a desirable outcome. So you might then go with something which is more straightforward and which mirrors what you've already got in place, but might then be less tax efficient from a local perspective. So it's often, I mean, often it will depend on, you know, the size of the population, who, you know, who are you incentivizing, because some companies will cascade options right down and...

so all employees will participate in the equity plan.

for some companies it's a much smaller audience and a much smaller group of their senior hires. So clearly if you send a senior hire to the US and they're really important to incentivise, then you might put in place something bespoke and specific which meets local tax criteria for that individual. But if you're doing it on a much wider basis, then again it's more complex to administer. So that's another factor which companies take into account when they are

Samantha Lenox (22:07.89)
plans overseas.

Adam (22:10.378)
Yeah, absolutely. And you talk there about designing the scheme with the sort of end objective in mind. And obviously the objectives of the scheme presumably have different considerations. So if you're using the scheme to motivate, you know, to attract talent versus to retain talent, I presume there are different focuses and different metrics and targets and design principles you need to adhere to, right?

Samantha Lenox (22:36.243)
Yeah, I mean, you know, I suppose, I suppose the first question is if you're using it as a recruitment tool, then, you know, the first question really would be, well, who are your competitors? And how do your competitors recruit and incentivise and retain talent? So that's that that's clearly an important question. I mean, if you're thinking about it as a

an ongoing retention tool, then to your point, there probably will be service metrics around that. So investing, which is the term that companies commonly talk about this investing schedule is a tool to reward service because it's a time-based reward.

If it's, you know, if you've got particular performance objectives, like, you know, for example, an exit, then you'd implement an exit scheme and there will be, you know, the monetizing and the exercise rights will be designed around that particular milestone. But I suppose, I mean, I think it's good to think about it on this kind of granular basis in principle, something like, you know, an employee incentive, an employee enterprise management incentive scheme.

can sort of talk to all these objectives. So, you know, when companies put plans in, often they will put plans in which have the ability to make different kinds of awards, which can add performance conditions to individual awards. So you should set up a scheme which gives you the flexibility to meet various objectives when you're, and that's an important design consideration when you're putting in.

Adam (24:20.31)
And actually on that point, how flexible should you be? Because obviously you don't want the scheme to change every three months with different performance criteria or different, you know, what's the sort of best practice in terms of you obviously don't wanna set it up and fix it for life, but you want some flexibility as you say.

Samantha Lenox (24:29.251)
No.

Samantha Lenox (24:38.919)
Yeah, absolutely. So you want flexibility. So you want to design a scheme which has a set of defined parameters at the outset that can be tweaked for individuals.

So you want to provide the facility, for example, to add particular conditions to an individual's award, be those service or performance conditions. But to your point, when you set up a scheme, the stakeholders will agree what the parameters of that scheme are. And it's not, as you say, it's not desirable to...

be amending those principles on an ongoing basis because that creates complexity. It also creates more opportunity for things to go wrong. Another really important question to be thinking about is who owns this scheme, who in the company is responsible for the implementation and operation of this scheme.

Samantha Lenox (25:52.247)
if that individual, you know, you don't want to have too much knowledge in one person because they might go. So having a tool book or a guide which sets out how the scheme works and how it needs to be administered and operated is really important. So that when you have staff members coming in who become responsible for the scheme, they understand what the objectives are, what they need to do to ensure it's ongoing compliance.

And then so there's that piece around so who owns it at the company then there's also the wider piece in terms of if you've got external investment then often you're going to need to get shareholder or investor director consent to do things with your scheme because when you get external funding usually or often if it's a VC there will be a term sheet which says this is what we need you to create an option pool, this is the vesting terms that we would expect you to adhere to.

Now, if you then want to vary that down the line, you'd need to go and get shareholder or investor director, investor consent to do that. So I suppose the overriding, you know, sort of objective should be to create a scheme which is compliant and sort of meets everybody's, all your stakeholders' objectives at the outset, which allows you to do things later on should you need to.

and also to make sure that whoever's administering the scheme has the information that they need to ensure that it's compliant and they're getting the right consents on an ongoing basis.

Adam (27:29.454)
That's great. And you talk there about loads of relevant points around, which I guess overarching is administration and communication. And in terms of the communication, you mentioned about your admin, you mentioned about your shareholders. How in your experience is this best communicated to the wider employee base? Because you're going to have those employees who are included, those employees who are excluded from the scheme for whatever reasons, and you need to make sure that there's the right comms.

Samantha Lenox (27:37.875)
Hmm.

Adam (27:58.434)
that goes out to each group. So what's, I guess, a few best practice points from your experience on managing that communication.

Samantha Lenox (28:06.263)
Yeah, it's really important because you know you put these schemes in and you communicate them if you've got a senior high you know it might be part of their offer letter that they're going to get equity in the company and everybody agrees at the outset you know what the terms of that thing are you then put it in and you know you're losing a significant amount of value if you're not taking the opportunity to communicate that.

to your employees because otherwise it's just a piece of paper and people are okay you know if the company sells then I'll get some value but you're not making the value creation opportunity real to employees unless you're communicating on an ongoing basis so I think there are some there are various you know good practice points I think first of all there's something around how you communicate.

the scheme when you roll it out and thinking about the tools to enable you to do that. So a webinar for example, yeah you need to think about your audience, you know how will they best understand and you know value the benefit that you're bringing. So it might be a webinar, you probably will have some written materials which set out what the purpose of the scheme is, you know what the value creation opportunity is.

Then another sort of thing to think about is you know whether you'll implement some sort of online portal. So lots of the Shareplan administrators and increasingly you know for very small companies have got packages to enable you to manage the administration and the communication of your scheme through an intranet. So as an employee I can go into.

know a portal and I can see what stock award I have, I can see you know when it's going to vest, I might be able to add a financial value based on the latest funding round or you know based on data that is in the public domain so that I can understand what the monetary value of that of that award is. So there's something around communicating at the outset so people really understand what they're getting and then also communicating to the extent you can.

Samantha Lenox (30:29.059)
on an ongoing basis so that people understand what the value of that particular reward is. And then, you know, if you're thinking, you know, you might have a competitive offer to go somewhere else, well, actually, if you then look at your equity award and think, oh, my equity award's worth this, if I go, I'm going to lose it, then, you know, that's how you're sort of that's the retention element.

for employees to understand the value of that. And I mean, in the past, I think it was more difficult for private companies to make the value real to their employees. You know, and there was, and obviously there was sort of confidentiality issues around how much and to what extent you'll communicate. But increasingly, there are more and more tools available.

to communicate financial information relating to the value of the award to the employee and it might be that there's an annual valuation event for example. So this is you know that which is a really I think it's a really positive development because

it does enable people to better understand the value of their equity and to replicate what you would get if you were in a PLC and you could just you know type in the share price okay and then you very clearly understand what the value of your orders. So there are tools increasingly available to enable private companies to communicate meaningful financial information on an ongoing basis to ensure that employees really understand the value of the benefit.

Adam (32:03.406)
That's fascinating. I feel we could go on for another hour or more just to and not even scratch the surface so like really interesting stuff and But we have to move on and I'm gonna move us to a business book bonus section Which is basically a section where we're asking all of our guests to provide us with a recommendation For the audience of a business book or some other piece of business content That's helped them during their business career and they would want to recommend

to our audience. So Sam, what business book or other content would you like to recommend?

Samantha Lenox (32:38.411)
So, Adam, I'm going to recommend a book by James Kerr called Legacy. I don't know if you've come across it. And so James Kerr is a leadership expert and he spent some time with the All Blacks, the New Zealand rugby team. And

Adam (32:49.343)
I have not.

Samantha Lenox (33:06.403)
sort of you know spending time with them observing how they behave, how they work together as a team to achieve you know the highest possible you know outcomes and what he's done is based on his experience and his time that he spent with the all blacks he's written this book on leadership and with various lessons and some of it is you know stuff that

will be sort of well known and sort of well thought through. But there are, I think additionally, some really interesting insights into, you know, what makes a successful team. Because it's all about the All Blacks, it's all about the team and the, you know, acting for the greater good of the team. How do you, you know, pull together as individuals to achieve the best for the team? And there's some, you know, I really like the...

analogy about sweeping the sheds which is about you know nothing is too small so as a leader you know don't be afraid to sort of be humble and the small things are important to sort of break down hierarchy so there's I think that I mean there are 15 there are lots of different lessons in it and I think most people will be able to take something away from the book

Samantha Lenox (34:34.299)
what James has to say. So that's my top tip.

Adam (34:39.598)
Very good. Very good. Well, that sounds like a good one and we'll put a link to James's book in the show notes and thank you for the recommendation. And I guess is there anything... Well, there's a lot we haven't covered, but is there anything you'd like to say before we wrap up?

Samantha Lenox (34:55.212)
Yeah, I mean, you know, share options can be quite complex, I think. You know, there are a lot of different considerations to think about. So, you know, my sort of main recommendation is to get good advice and to regularly check in on that advice because often, you know, when these things get put in, you know,

everybody understands what the scheme's trying to do and it's all compliant and so on. And if it runs for a few years, you know, processes can fall down. So I would say, you know, check in on that scheme, particularly if you do think there's a corporate event in the offing, because it's much easier to now, you know, it's much easier to fix stuff when you've got a bit of a lead time, rather than having to fix it during the transaction and time and time again having

done a lot of transactions. This is an area which raises red flags on a transaction because often it has been implemented correctly but things have just fallen down since it was implemented and that just causes noise and it causes cost and you know people are being asked to give sort of to take risks on.

which they wouldn't have wanted to have the schema been set up correctly and continued to be operated correctly throughout its life. So those might I think those are the overarching tips that you know make sure that you set the thing up well and get good advice at the outset and do check in you know every now and then to make sure that it is still operating in the way that it should be and in a compliant manner.

Adam (36:43.554)
Great advice there. Well, thank you very much. And thanks for joining me, Sam, on the Fractional CFO show. I really appreciate your insight, your perspective and your time. Thank you.

Samantha Lenox (36:53.095)
Thank you, it's been great. Thank you for having me.