When floating on a public market such as PLUS, a share option scheme can be a tax-efficient way to retain and motivate key staff. GrowthBusiness talks to companies about how it’s done.

When floating on a public market such as PLUS, a share option scheme can be a tax-efficient way to retain and motivate key staff. GrowthBusiness talks to companies about how it’s done.

Before digital marketing business dotDigital joined PLUS via a reverse takeover in January, MD Peter Simmonds had already made up his mind about one thing.

‘We had decided to allocate share options to all staff,’ says Simmonds. ‘It was very important for us to do that at the point of admission, a way of saying, “you are all now sharing in the future of this company”.’

Predictably, the news went down well among the company’s 40 employees, but this is no one-off shot in the arm. ‘We are going to repeat the process annually so that people build up a larger and larger interest in the company. Next year we’re going up to 66 staff, so 66 will get options.’

Naturally, you don’t need to be publicly quoted to grant options. Richard Goodfellow, executive commercial director of biotech venture Scancell, says the company has had an option scheme since it was founded ten years ago. But he adds that a flotation on PLUS last year has encouraged option holders to view those bits of paper in a new light, especially as the company’s share price has increased from 30.5p to 52.5p over the past few months.

‘For our kind of company, you need a long-term commitment from your scientific staff,’ says Goodfellow. ‘Some companies take the view that share options are only for directors and senior management, but I’ve always believed that extending them to everyone is an important incentive. It means everyone has an interest in seeing the share price go up.’

Key players
Jon Isaacs, a director at PLUS advisory firm Alfred Henry Corporate Finance, explains that share option schemes aren’t merely a generous giveaway. They’re also intended to lock in important staff for the longer term, with a ‘vesting period’, typically around three years, during which the options remain just that. When people leave the company, they generally lose the options.

Isaacs adds one crucial point. Most companies with gross assets of less than £30 million, subject to certain conditions, can have their share option scheme approved under the Enterprise Management Initiative (EMI), resulting in tax savings for both the option holder and the company.

‘For the option holder, any gains they make are taxed as capital gains rather than income, so at 18 per cent rather than potentially at 40 per cent,’ Isaacs elucidates. ‘As for the company, it won’t have to pay tax or national insurance on the options.’

So how much of your company should you give away? Isaacs points out that it’s a balance between the need to incentivise managers and staff and looking after the interests of shareholders, who will be diluted once options are exercised. Simmonds says he has set the ceiling at 5 per cent of the company, and in this first year of being quoted is ‘nowhere near reaching that’. Isaacs states the ‘market expectation’ is that options will account for no more than 15 per cent of a company’s total capitalisation.

Apart from this deferred cost to shareholders, Isaacs says the only cost to the company of setting up an EMI-approved scheme would be legal and advisory fees amounting to perhaps £3,000 or £4,000. Paradoxically, though, international accounting standards require the options to be valued and included as a cost in a company’s profit and loss statement, even though ‘you could argue the options aren’t costing the company anything.’

Accounting anomalies aside, there is clearly a lot to be said for company share option schemes as a tax-efficient employee motivation and retention tool, especially compared to simply giving away shares. They do, however, have their drawbacks.

‘It’s important for staff perception that we’re listed’

One obvious limitation is that options only work if a company’s shares keep rising. If the price drops after options are given out, they become virtually worthless. ‘We’ve seen a lot of companies where share options have gone underwater,’ says Isaacs. ‘If it’s because of circumstances beyond the employees’ and directors’ control, it’s not uncommon for the old scheme to be rewritten and new options to be granted.’

Another problem for smaller companies may be that there is a limited market in their shares. Scancell’s Goodfellow says, ‘We had our eyes open when we listed, so we were aware this might be an issue, but it hasn’t prevented trading taking place.’

In reality, the most likely exit for Scancell’s option holders is through the company being sold, which is its current strategy. ‘It’s important for the perception of staff [that we’re listed], but I don’t think anyone expects to realise the value of their options until an exit,’ Goodfellow adds.

Simmonds of dotDigital has no regrets about introducing the scheme. ‘My big mantra in business is goal alignment,’ he remarks. ‘As a result of our option scheme we have 40-odd people interested in seeing the company’s value grow.’
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PLUS Markets is the new stock exchange in London for small and mid-caps. Some 200 companies have joined the PLUS-quoted market, worth a combined £2.3 billion, while more than 7,000 entities, including all AIM stocks as well as many larger companies, are traded on PLUS. For more information please visit: www.plusmarketsgroup.com.