What makes a successful business? A great concept definitely, an entrepreneur with passion and energy almost certainly, but perhaps most important of all – a highly focused and motivated management team to drive it forward.

You don’t have to be a Dragon’s Den entrepreneur to conclude that an important way to achieve this is likely to be by providing equity incentives to key team members – but putting the theory in to practice requires careful consideration and sound professional advice.

In this issue of EveryMonth, we highlight areas to consider. The Everyman legal team is experienced in devising effective and simple share incentives. Take the time to work through the series of questions we have posed below and you should have a better idea of what will work for you.

Q1 Are you ready to share ownership?

Co-ownership brings additional responsibility. Can you achieve your objectives with a cash bonus scheme – without the complication of equity incentives?

Q2 What scheme is right for you?

Essentially, there are 3 choices:

1. Outright share ownership from day one.

2. An option to acquire shares over a set period or at a future date.

3. An exit-conditioned option to be exercised if and when the company is sold.

Q3 Which of these alternatives is best for me?

For start-up and early stage companies, the first option is likely to be best. For mature companies seeking to lock in key employees ahead of an early exit, the third option may be more appropriate.

Q4 How to fix the level of employee share incentives?

In a start-up, equity will be divided according to the cash contributions or salary sacrifices made by the key participants.

For a company expecting to exit within 5-10 years, a good approach will be to project an achievable exit value and use this to calculate a percentage that will motivate employees.

Q5 Are there any tricks to help make the share incentive more attractive?

One technique is to reorganise the share capital by issuing bonus shares making a higher number of shares available. This will have the effect of appearing more generous – even if each share is worth correspondingly less.

Q6 What are the risk areas for the entrepreneur?

A scheme structure must not frustrate the ability to sell the company at the price and timing of their choosing. This is easily achieved by including a’ Drag Along’ option in the Articles.

If there are 2 or more founders, it is possible for employee shareholders to end up with a ‘swing vote’ enabling them to assist in removing a founder Director. If this is a concern, then employee shares can be made non-voting.

Q7 What factors should be considered in valuing shares?

Share valuations can vary wildly depending on the valuer and the purpose of the valuation. Minority interests will frequently be valued at a substantial discount to a controlling interest. A well advised company can often achieve the valuation that it believes is important to its business objectives.

If you’d like further information please contact us by phone on 0845 868 0962, or by email: james.hunt@everymanlegal.com. We’ll be very happy to give you help and advice with this and other areas.