The best way to incentivise your staff with no cashflow cost

You may be a start-up or several years into the growth journey but at some point every entrepreneur will sit back and work out how to incentivise employees beyond just a salary, free coffee, culture and warm words. Most will have heard of share options and have an idea that they can be a great inspiration. They are indeed, and better still put no demand on your cash flow.

In expanding companies, options can help focus employees on the longer-term goals of the business. You may be aiming for a lucrative business sale in a few years; you're determined, committed and excited by the prospect. The big question is, do we share some of our equity in this business with some of the team? Will it enhance their commitment, and reward everyone with even greater value than if we stayed as we were?

How does a share option work? Very simply, the company signs an agreement with an employee giving them a right to buy a set number of the company's shares at a set price at some point in the future. So let's say Julie is granted 20,000 shares under an option contract at a £1 ‘exercise’ price and four years later her company is sold to an even bigger software business at £10 per share. Julie buys for £20,000, sells for £200,000 and makes a cool £180,000 gain.

Psychologically, options make an employee feel more appreciated, because they are a benefit that can be awarded alongside the usual salary package. You’re saying, ‘we want you to stay with us and help grow the business, because we really value your input’.

Pragmatically, options can also help to recruit staff at salary levels lower than they might attract in other, bigger companies. If your company is exciting enough, a mix of salary, bonuses, share options, free pizza and diet coke or whatever can have the edge on joining some big, bureaucratic multinational.

Option scheme design is very flexible. Options could vest over a period, perhaps so many shares per year over three years, or perhaps simply have all of the options vesting on the date of an exit event, so that shares are bought on the day of the company sale and then immediately sold alongside the existing shareholders.

Any gains made on selling shares will of course attract the taxman's interest, and an employee would normally pay income tax at up to 45% (plus NI) on their gain. However, there is a brilliant scheme which removes the tax nightmare and enables eligible employees to pay capital gains tax instead, and at a rate of only 10%. It's called the EMI scheme and it’s easily the best employee share scheme out there.

Introduced by the Government specifically to encourage employee share ownership, the scheme is supported by all sides in Parliament. EMI ‘wraps’ really good tax benefits around what would otherwise be a straightforward share option contract between the company and an individual. Under EMI no income tax is payable when the options are granted, or when the options are exercised to buy the shares. When an employee sells their shares, they will keep 90% of any profit. The company itself also gets a tax credit which is offset against its corporation tax.

Costs involved in setting up a scheme are low, as are ongoing expenses, so there is little cash outlay compared with the huge incentivisation payback.