Companies are constantly looking for ways to recruit and retain top talent. One way to ensure workers stay and contribute to the company is through an employee option scheme. An employment option scheme is a type of incentive package where the company allows employees to buy a number of shares in the future at a fixed price on the date the option is granted.
An employee option scheme gives workers a sense of accountability. It also encourages them to work harder in order to obtain the stock options as rewards for their performance. Businesses can also choose to offer stock options as a retirement plan or as a type of severance package to guarantee security for employees exiting the workforce.
Key Factors to Consider
There are definite advantages to implementing an employee option scheme and you can choose one from among the available strategies. Knowing which one best fits your structure is key to its efficient roll-out, as this will determine employee qualifications, vesting schedules, and tax implications.
Here are some key factors to consider:
1. Plan Rules
Plan rules are essential in implementing an employee option scheme. These plans include the agreement between the employer and employee and spell out the terms and conditions to qualify for the scheme. It also informs both parties of their obligations with regard to taxes and other payments. Aside from this, the plan rules also govern employee exits and unvested options. Plan rules serve as the company’s protection in executing employee option schemes.
Your company’s legal department can handle these agreements. In the absence of one, you can use a platform that allows you to easily handle tasks such as drafting plans that reflect your company’s and employees’ interests, raising capital, and getting support and advice from legal experts.
2. Type of Employee Option Schemes
Companies need to implement employee option schemes that are suitable for the structure and purposes of their organization. It can be implemented as one of the following:
- An Enterprise Management Incentive (EMI) is ideal for startups and small companies. An EMI allows workers to acquire shares as they achieve certain performance indicators.
- An Employee Share Option Plan (ESOP) is one where companies give employees options to purchase shares at a given time. Holders can then decide to convert their options into shares or to hold onto the options until they exit from the company.
- A Savings-Related Share Option Scheme or Save As You Earn (SAYE) requires payroll deductions to fund a savings account. Employees are then given an option to buy shares and exercise their options when the savings contract matures.
Once the company has identified which type of employee option is applicable, they can now determine which among their employees are eligible for the chosen scheme. Companies can offer such a scheme to employees who meet certain requirements such as length of service, salary levels, seniority or consider KPIs as qualifiers for options.
An advantage to employee option schemes is that workers are encouraged to stay longer with the company in order to avail of additional options that are convertible to multiple shares in the future. This strategy also works as a great retention tool and can also compensate for lower salaries compared to other offers.
4. Vesting and Conversion Period
Management must also decide when these options are granted and when conversion to shares can occur. They can either choose to do so in regular intervals (3-4 years, every 5 years, etc.) or they can offer employees the option to convert when they exit the company as in the case of retirement or as part of a severance package. Vesting and exercising options can also serve as an assurance for option holders when the company is being sold.
5. Tax Implications
Employee option schemes are often liable for taxes such as income tax, NICs, and Capital Gains Tax upon the exercise of options. Should workers choose to convert their options into shares, they’d need to shoulder income tax and NICs based on the difference between the exercise and market value of the share. Once they decide to sell their shares to the open market, employees are also liable for Capital Gains Tax.
Employee option schemes are effective tools that provide employees with enough motivation to perform well and stick with the company in order to receive promised incentives. Option schemes can take the form of EMIs, ESOPs or SAYEs. A comprehensive plan rule details employee eligibility, vesting and conversion periods, tax liabilities and exit clauses. These are essential features, as they ensure that companies are protected at the time of conversion or exit. At the same time, the plan rules ensure that employees receive their acquired incentives in due time at an amenable price.