When it comes to incentivising top talent, offering equity stakes is an increasingly popular strategy within recruitment firms. Equity stakes – whether in the form of share options, Class A or B shares, or other compensation – represent more than just financial rewards. They symbolize a vested interest in the firm’s growing success, aligning stakeholders with long-term growth goals. But what exactly does equity entail, and how should you approach an offer?

Firms often use equity to attract and retain high-performing employees, particularly when immediate cash flow is limited. Equity can bridge the gap between competitive compensation and creating a sense of ownership. By tying financial gain to the company’s success, equity incentivises employees to think like stakeholders[1].

Offering equity rather than cash or bonuses is also a practical choice for smaller businesses and start-ups. Early-stage companies often lack the liquidity to offer competitive salaries or significant bonuses. Equity allows them to reward and attract employees with the promise of long-term financial gain, aligning their interest with the company’s success, rather than just a good salary.

In an industry like recruitment, where a generous hike in base salary is rarely enough to incentivise a successful fee earner to move, this strategy is particularly important to be able to recruit and retain top performers who are critical to business growth[2].

What are the different types of equity?

1. Stock options

Employee stock options (ESOs) give employees the right to purchase company shares at a predetermined price (strike price) after a specified vesting period. Once exercised, the employee becomes a shareholder. Stock options are particularly popular in startups as they offer the potential for significant financial gain if the company’s value increases over time[3].

ESOs align employee interests with company performance and offer a high upside potential if the company succeeds. However, they also come with tax liabilities (once the option is exercised) and a risk of potential financial loss if the stock price drops.

Common schemes in the UK include:

1. Enterprise Management Incentive

Where employees are given the option to own shares (at an agreed price) in the company if they meet a specific performance criteria. This scheme is popular with start-ups because it allows them to compete with larger firms on a salary. Companies can award options worth up to £250,000 per individual and £3 million overall[4]. However, several requirements must be met for the company to qualify to grant EMI options. These conditions also need to be met to qualify for the tax advantages – such as no income tax or national insurance contributions at exercise[5].

1. Company shares option plan

Allows employees to buy up to £60,000 of shares measured by reference to the tax value of the shares at the date of grant of the option[6]. If statutory conditions are met, any gain on the options will be free from income tax and national insurance contributions[7].

1. Save as you earn

This is the most popular UK share scheme because businesses can offer it to employees of all levels, unlike some schemes aimed only at higher-level employees. For the first 3-5 years, you can save £5-500 a month (deducted from your gross salary). At the end of this period, you can buy shares in the company at the price from when you started saving (however, you can decide not to buy the shares and instead withdraw the money as cash). This method typically gives you a 20% discount on the market price of those shares[8]. Participation in this scheme must be offered to all employees.

1. Share incentive plans

These shares can be acquired through four different methods: free shares, partnership shares, matching shares, or dividend shares. Employees can receive shares for free or buy shares through deductions from gross pay. Bought shares in their employer, or employer’s parent company are then held in a special type of employee benefit trust[9]. An employer can give free shares up to the value of £3,600 (per employee per tax year), or an employee can buy up to £1,800 worth. Shares must be held for 3-5 years for maximum tax efficiency, and participation in this scheme must be offered to all employees.

2. Class A and B shares

Class A shares typically grant higher voting power and are often reserved for founders, executives, or key stakeholders. For instance, a single Class A share might carry 10 or more votes compared to a single Class B share. On the other hand, Class B shares generally carry fewer voting rights and are issued at a lower price, making them more accessible to employees. They are a practical way of distributing equity without ceding substantial control[10].

Class A and B shares provide flexibility in distributing ownership and voting rights and allow companies to attract employees at different investment levels. However, the reduced voting power for Class B shareholders can lead to dissatisfaction if decision-making appears inequitable[11].

Key questions to ask when offered equity

When evaluating an offer, clarity is critical. Consider asking questions such as:

• What type of equity am I being offered?
• If an option, what is the current value of the option?
• What is the projected value of options at the point of a capital event?
• What is the vesting process?
• What is the process for converting shares into cash?
• What happens to my equity if I leave the company or if the business is sold?

Equity share schemes are an effective way of rewarding employees by providing a better renumeration package that can also provide tax benefits. If offered on favourable financial terms, the worst-case scenario for employees is that they might have chosen to buy an equity that does not pay out as they might have envisioned[12].

Equity can be a powerful motivator, but it is not one-size-fits-all. Understanding the types of equity and asking the right questions is critical in making the correct choice for yourself and ensures that you are not only aligned with the vision of the company, but also fairly compensated for your role in achieving it.

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[1] https://www.investopedia.com/terms/e/eso.asp

[2] https://www.recruiter.com/recruiting/the-boundaries-between-private-equity-venture-capital-and-executive-search-are-blurring-what-does-that-mean-for-recruiters/

[3] https://www.investopedia.com/terms/e/eso.asp

[4] https://harperjames.co.uk/article/what-are-employee-share-schemes-and-how-do-they-work/#section-3

[5] https://www.sjp.co.uk/individuals/news/what-you-need-to-know-about-receiving-share-options-as-an-employment-benefit

[6] https://harperjames.co.uk/article/what-are-employee-share-schemes-and-how-do-they-work/#section-3

[7] https://www.sjp.co.uk/individuals/news/what-you-need-to-know-about-receiving-share-options-as-an-employment-benefit

[8] https://www.sjp.co.uk/individuals/news/what-you-need-to-know-about-receiving-share-options-as-an-employment-benefit

[9] https://harperjames.co.uk/article/what-are-employee-share-schemes-and-how-do-they-work/#section-3

[10] https://www.investopedia.com/ask/answers/062215/what-difference-between-class-shares-and-other-common-shares-companys-stock.asp

[11] https://www.investopedia.com/ask/answers/062215/what-difference-between-class-shares-and-other-common-shares-companys-stock.asp

[12] https://harperjames.co.uk/article/what-are-employee-share-schemes-and-how-do-they-work/#section-3