Do it Right or Not at All …
Offering company shares and share options to employees has become so popular it is now expected as part of a compensation package when joining a B2B tech startup. Sharing success with the workforce that made it happen is generally a good idea, and far more appealing than handing out company-branded hoodies. It’s desirable because employees are being asked to commit themselves to a high-risk venture that may or may not succeed. However, whilst using an Employee Share Scheme (ESS) can be a worthy incentive, if it’s not done correctly, the reverse can also be true. Let’s look at what needs to be in place to make ESS work for the benefit of all.
Put the Legal Framework in Place Before Your Start
Any founder who started giving away company shares before first deciding how they will work and putting their house in order will know that this was a mistake. Getting proper legal advice from the start about how to structure your company shares is critical. This includes putting the correct company and employee documentation in place that governs this. Nothing should be taken for granted or left to chance, including how you write your contracts of employment.
Prepare for Investment
Do not ignore the importance of getting started correctly. Ignore this at your own peril, and accept you may otherwise have to deal with the consequences of a very messy and even non-compliant company structure. Fixing the mess could cost you more in the long run than doing it right in the first place. Making mistakes is not only potentially costly but may not serve you when the time comes to talk to investors, who do not like to invest in badly run businesses with non-compliant or chaotic governance structures.
Consider Company Culture
In the excitement of starting your new business, you are likely to make mistakes, take shortcuts due to a lack of funding, and maybe not fully appreciate the value of taking proper legal advice. Formulating an employee share scheme is one area you cannot afford to get wrong. Such schemes are designed to act as an incentive to attract and retain talent and will have an impact on your company culture. It’s important to consider what kind of company culture you are trying to create from the start, and the terms in the scheme must reflect how you want people to think, feel and act in the business.
Transparency and Fairness
Make sure the share ownership model is transparent and fair and determine what rights employees will and will not have. Decide up front how you will handle specific scenarios, such as how employees will earn their shares, what the allocation per employee type will be, when they will vest, what happens when people leave the business early, and so on. Always make sure decisions concerning employee shares and how they are handled are done with fairness in mind and not greed, or the company culture you worked so hard to create will turn toxic very quickly.
Keep Bad Founder Behaviour in Check
Do not corrupt your business with negative behaviours if you suddenly realise you didn’t put the proper share structure and mechanisms in place. This was your own doing, and employees should never be penalised for your own lack of foresight. If you didn’t get proper legal advice at the start, do it now and clean up the situation properly, rather than making knee-jerk reactions. Always act fairly and in the interests of your business and your people. Employees should be able to understand the details and know exactly where they stand. If they don’t know the answers to simple questions about your share scheme, then it hasn’t been done correctly, is poorly documented and hasn’t been communicated. No startup can afford to implement an ESS that simply doesn’t work because it was never properly conceived, structured and documented.
Get Proper Legal Advice
It may be better not to offer employee shares at all than to do it badly. Wait until such a time that funds are available to do things correctly. Engage with an experienced legal professional before introducing an employee share scheme. Any employee equity offering must start with the Memorandum and Articles of Association. This document will govern your share structure and how employee shares will work. It must be prepared by a professional and properly listed, which will then inform all employee documentation relating to your share scheme – ideally in plain English, rather than legalese.
Strategies for Effective Implementation of An Employee Share Scheme
- Start With Proper Professional Advice: Engaging legal and financial advisors from the start can help navigate the complexities of setting up and managing an equity compensation plan. Professional advice ensures compliance with regulations and optimises the structure for both the company and employees. Do not officially offer shares to any employees until this is done and you can back it up with the proper documentation and information.
- Clear Communication: Transparency and fairness must be at the core of your share scheme if it is to be effective as an employee incentive. You must clearly document and communicate the details and terms of share options to employees, including potential risks and rewards. This can be done in a dedicated employee share scheme handbook, which helps manage expectations and ensures employees understand how their equity works. If you cannot answer simple questions relating to how the scheme works, this is a sign it has not been done properly, and you shouldn’t be engaged in the activity.
- Balanced Equity Distribution: It’s important to balance equity distribution to avoid excessive dilution. Founders and early investors normally retain enough ownership to maintain control and motivation, while employees should receive enough equity to feel they have a meaningful opportunity to share in the success of the business.
- Regular Updates: Providing regular employee updates on the company’s performance and potential valuation can help keep employees informed about the potential value of their equity. This transparency can maintain motivation and engagement. This must not be so frequent as to become a distraction, but regular enough to support the vision and keep everyone aligned with the strategy. This helps motivate employees through a clear understanding of the importance of their continued focus and impact on key tasks.
Equity That’s Fair and Equitable
When implemented effectively and fairly, ESS aligns with company culture and the interests of employees, ultimately driving the company’s success. Startups are known for their innovation and accelerated growth, so a good employee share scheme can add an extra layer of performance. It’s essential to manage this strategy carefully to avoid pitfalls such as dilution, unrealistic expectations, regulatory errors and compliance discrepancies. By learning from both good and bad examples, startups can use equity compensation to build strong, motivated teams that propel them towards success.
Don’t Kill the Goose
If you spend more time ordering company-branded clothing than setting up your company share structure and employee share scheme correctly, your startup is most likely to join the long list of failures that will never see their tenth year of operation. Sadly, there are countless examples of people who have joined startups on an equity promise, only to find out later that what was really on offer was not worth waiting around for. Employee expectations and reality can easily be misaligned, which is why full disclosure from the beginning is imperative to avoid disappointment. A well-implemented ESS can help you unleash the potential of your business, but a bad one can create a scenario where staff want to kill the goose that was supposed to lay their golden egg.
You may want to read: “Why Tech Startups Offer Equity to Employees.”
