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​​Legal Implications of Equity Incentives for Startups ​​ 

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Startups often adopt equity incentive plans to motivate and retain top talent while aligning their interests with the company’s success. If you plan to issue shares as compensation or run an equity incentive program, you will need to consider various legal aspects. This article will explore the benefits of equity incentives and essential legal implications surrounding using equity incentives in your startup. 

What Are Equity Incentives? 

Equity incentives refer to a company offering equity stakes to its employees, advisors, or other stakeholders as compensation or motivation. For example, you might incentivise employees by offering them shares or options in addition to their usual earnings. This scheme could motivate employees to work efficiently, add value to the company and increase their income through their shares. 

The Benefits of Offering Equity Incentives 

A significant benefit of offering equity incentives within a startup is establishing alignment between stakeholders and the company’s motivations and the company’s success. When others have a stake in your company, their interests become intertwined with the success of your business. This alignment incentivises individuals to contribute their best efforts towards your startup’s growth and success. Unlike traditional forms of compensation, such as salary bonuses, equity incentives directly link an individual’s performance and the company’s overall value. As a result, those who hold equity become partners in the venture with you, sharing in the risks and rewards, no matter the size of their stake. 

Equity incentives can be crucial in attracting new hires and retaining talent, particularly in competitive industries. Offering equity incentives as part of a compensation package gives your startup a competitive edge when recruiting and incentivises employees to stay. Your employees will benefit from your startup’s long-term success and the company’s growth. 

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1. Understanding the Different Employee Share Schemes 

In the UK, there are different types of share schemes that you could use to provide incentives to your employees. The following table breaks down several of the available schemes that are available to your startup company. 

SchemeExplanation 
Enterprise Management Incentive (EMI) schemesThe EMI scheme is a popular choice among UK SMEs. Under this scheme, you can grant employees share options (the right to buy shares within a specified period). This government-backed scheme requires your company and its employees to meet specific eligibility criteria to qualify. 
Company Share Option Plans (CSOP)The CSOP would also enable you to grant options. Similarly to the EMI scheme, benefits include tax advantages and flexibility. Your company must also meet specific eligibility criteria to issue options under a company share option plan. 
Save as You Earn Option PlansThis scheme involves employees contributing to a savings account as they earn. They can either exercise their options, enjoying a 20% discount on market value or withdraw the savings. However, you can only issue options to particular employees under this plan. 
Share Incentive PlansUnlike the others, this scheme would allow you to issue shares to employees.
Non-Tax Advantaged Share Schemes Suppose your startup is ineligible for the other schemes. In that case, you can still issue shares or options to your employees, advisors, and others, but doing so would not involve tax benefits. 

It is a good idea to seek legal advice regarding equity incentive stock options plans. This enables you, as a startup founder, to make an informed decision about which scheme to choose. 

2. Equity Dilution 

It is likely that your company already has multiple stakeholders, including you, your co-founders, and investors. This can mean your portion of ownership is already limited to a certain percentage. Providing equity incentives will further dilute your ownership, decision-making and voting rights, so it is essential to consider how much you are willing and able to contribute to providing incentives. 

Carefully consider how much equity you will give others to avoid over-diluting your ownership. Then, consider the impact of this on your and your co-founders’ level of ownership and adjust your plans as necessary. When you have made an informed decision about how much equity you will provide to your company’s employees, advisors and others, set this total amount aside. For example, you might set aside 10% of the company’s equity as a pool to provide incentives. 

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Key Takeaways

Many startups offer equity compensation as an added value to attract and retain top talent and a necessary boost to pay packages in the early stages when cash flow is limited. Equity incentives can also effectively align your employees’, advisors’ and other interested parties’ motivations with your startup’s goals. If individuals have a stake in your company, they will want to see it succeed. However, before you introduce equity incentives for your staff, you need to consider several key legal considerations, which include: 

  • choosing an appropriate employee share scheme; 
  • considering the tax implications of offering equity incentives; 
  • being aware of equity dilution; and
  • seeking expert legal advice to enable you to make informed decisions.

If you would like to find out which equity incentives are appropriate for your startup and the legal implications of issuing shares, contact our experienced startup lawyers as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.  

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Jessica Drew

Jessica Drew

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