The benefits of giving employees a stake in the business by way of equity participation are well rehearsed.
Often the decision comes down to a choice between allocating shares upfront, effectively making the employee a day-one shareholder, versus granting them a tax-efficient enterprise management incentive (or EMI) share option.
Making employees a shareholder in the business often feels like a bigger leap of faith than granting options. Why is that?
Part of the answer lies in the fact that an option delays the acquisition of the shares until a future point in time. If exercise of the option is structured deliberately to coincide with an exit of the business, the employee is only a shareholder for a scintilla of time.
Another reason is that being a shareholder in the business has greater emotional resonance than effectively being a deferred shareholder and that resonance can cut two ways.
Bringing someone into the equity feels like there should be a high bar to entry; the employee needs to prove themselves first. For the employee, being brought into the equity feels like special recognition and achievement.
However, the emotional appeal of being considered a co-owner in the business, even if the shareholding is very modest, should not be underestimated.
This is where so-called growth shares may come into the equation. The term growth shares refers to a special class of shares that have no right to participate in the current equity value of the company and only an interest in the company’s future growth; a bit like a market value employee share option.
Growth shares help with holding the employee’s feet to, if you like, the performance fire. Unlike becoming a ‘normal’ shareholder, a growth shareholder can still be required to ‘earn’ their equity by reason of creating future equity value.
Growth shares might be an attractive option if an employer is, for example, a mature business with significant equity value; a business owner who wants to ring-fence that equity value for themself; keen to give employees a stake in any future value that they help create; or unable to grant EMI options for whatever reason but would still like to replicate the economics of an EMI option.
In these scenarios, growth shares can be a great solution for ticking lots of performance alignment boxes.
The design of growth shares does not have to be that complicated but the conversations surrounding them should be relatively sophisticated.
These will need to include determining what ‘success’ looks like, understanding the business drivers for creating equity value, being focused on achieving certain strategic outcomes – in other words, exactly the type of conversations any owner should be having with their employees.
At one level, growth shares are simply a bundle of rights that inherently recognise the importance of the employee being aligned to the strategic objectives of the organisation.
At another, and this is the key takeaway for reward and benefits professionals, they represent the faith being placed in an employee by an employer; faith that they are the right person to help deliver on that organisation’s important objectives.
And that, of course, can be a powerful incentive that benefits everyone: the organisation, shareholders and employees.
Elena Visser is a solicitor in the corporate finance and incentives team at Burges Salmon