Interviews, insight & analysis on digital media & marketing

How to incentive your workforce: the legal view

By Katherine Mortimer, Royds Withy King

Marketing agencies are seeing increased demand and rapid growth. Yet a hot labour market is making it tough to recruit new staff pushing salaries up. Agency chiefs are increasingly looking at share schemes to attract, retain and incentivise their teams.

The question many digital marketing agency founders face is how to create a sense of ownership within a workforce. How do you incentivise your workforce and create a culture in which your employees feel as invested in your company as you are? The difficulties are acute when cash flow is tight and boards are looking particularly carefully at pay rises and bonuses.

There are clearly all sorts of variables that come in to play and here we look at just one option; giving the employee a right of ownership. This can be achieved by the transfer or issue of shares (including growthshares) immediately, or giving the employee a right or option to acquire shares in the future.  Where a shareholder has growth shares their entitlement is limited to a share in future growth.  For established agencies this can be attractive because this necessarily reduces the acquisition price.

For share options there are several HMRC approved, tax efficient schemes and for smaller, generally owner managed, agencies an EMI scheme is a popular choice. 

The basic structure is simple.

The agency gives the employee the right to acquire shares at some point in the future.  Both the price and the maximum number of shares over which the option can be exercised are fixed at this point. This is known as the date of grant. Exercise of the option can then be subject to bespoke performance conditions, or structured so that it is only exercisable on an exit, whether that is a trade sale, equity investment or a listing.

The employee pays nothing to receive their option but then pays an exercise price when they “exercise” it, which is the point at which they become a shareholder. There are generous tax benefits for employees should they then sell those shares, with any gains taxed not as income but through the capital gains tax regime with reliefs available.

The key documents are a set of option rules and then a bespoke offer letter for each participating employee. Subject to the requirements of any existing shareholders’ agreement, setting up the scheme does not generally require shareholder approval. However the grant of a right to acquire shares (which is what an option is) does. It requires shareholders to give the directors authority both to grant the right and to do so without reference to any applicable statutory or constitutional rights of pre-emption.

Exercise at the end of a performance period

In this structure, participating employees are given the right to acquire a maximum number of shares at some point in the future. There is no minimum holding period. This structure is commonly used where the agency anticipates being in a position to pay dividends and wants to reward, retain or recruit staff by doing do.

Arrangements can be bespoke for each option holder, so, for example, a long standing staff member can be given the right to exercise earlier than a new recruit. An important factor to remember here is that because the option holder will become and continue as a shareholder, the employer needs to consider what structure needs to be in place should he leave or at some future point, there is a third party sale. Following exercise of the option, the relationship is governed by the articles of association of the company, not the option rules.

Exit only options

These are commonly used when employers are aiming for a sale over the next three to five years. Exit only options provide a mechanism for employees to share in that growth.  In this structure, the option holder is given the right to exercise immediately before the third party sale. 

If structured correctly, the employee does not have to supply funds (the exercise price) in advance, this can be taken from the sale proceeds.  He is only a shareholder for a millisecond.  In this way the company does not have the administrative burden of additional shareholders in the medium term and there is no risk to the option holder of paying for shares without knowing whether they can be sold.  

The ideal time to set this sort of option up is right at the start of the journey when the share price is at its lowest. 

Qualification and statutory requirements

EMIs are not suitable for every company.  To qualify the company must be an independent trading company with:

  • gross assets of no more than £30 million; and
  • fewer than the equivalent of 250 full-time employees.

This means that where there is a group, options can only be granted over shares in the top holding company.

To be eligible, an employee must work for the company for at least 25 hours per week or if less, 75% of their working time.  EMI options cannot be grated to non-executive directors or consultants.

Employees cannot be granted EMI options if they or their “associates” have a “material” interest in the company whose shares are used for the scheme.

Employees can only hold unexercised EMI options over shares worth up to the current EMI individual limit (currently £250,000).  A company cannot grant EMI options over more than £3 million worth of shares at any one time.

Options must be capable of being exercised within ten years of the date of grant and can only be exercised within a period of 12 months of the option holder’s death.  The option rules will commonly provide that they lapse on cessation of employment (although early exercise may be permitted in some circumstances).