How start-ups can compete with big firms for talent

Offering share options in the company in order to attract and retain talent

One of the biggest challenges that many start-up founders will face is how to attract and retain the very best talent possible. It has always been difficult for start-ups to get the right people but it has become increasingly difficult in recent years, especially in the tech sector. By their very nature, start-ups typically don’t have the funding to compete with larger organisations on salary alone. So start-ups need to think about other financial incentives to attract and retain key employees. One possibility to consider is offering employees share options in the company.

Share based incentive scheme

A share option is a right given to an employee to buy a share in the company at some time in the future, at a price that is fixed on the day that the option is granted. Assuming that the company does well and the share price increases, the employee has the opportunity to buy shares at a price less than market value.

How an option scheme typically works

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• An employee is granted the option to buy shares in the company at a fixed price. For example, an employee might be granted the option to buy 5,000 shares at €1.00 per share. At the discretion of the company, the option price can be at a discount to the market price on the date the options are granted. The option might be granted at a share price is €1.00 while the market value of those shares at the time might be €5 each.

• Although an employee might be granted the options on a particular date, a vesting period is usually built into the options, whereby only a portion of the shares can be exercised at any one time based on certain conditions or dates. So the 5,000 option shares might vest over 4 years (1,250 per year, starting on the first anniversary of the granting of the option)

• The options have to be exercised within a specific period of time, usually within seven years from the date the options are granted.

• Given that there is unlikely to be a market for shares of an early stage start-up company, share options are not usually exercised until an event such as a sale of the company occurs.

Option Pool

The likelihood is that as the company grows and staffing levels increase, the need to incentivise all levels of employees, from entry level to key senior management, becomes more important. It wouldn’t be unusual to ring-fence between 10 per cent and 15 per cent of the share capital of the company for the option pool available for allocation to employees.

From the employee’s perspective, it can be a very good way to participate and share financially in the success of the company. However, there is the risk that the share options will have little, if any, value in the long term. And of course there’s the tax on share options to be considered.

Tax implications

As good as share options sound as an incentive for employees, there are two separate tax implications for the employee. Firstly, although there is no tax charge at the time of granting of the option, when the option is exercised, income tax, Universal Social Charge and employee PRSI are all payable on the difference between the option share price and the market share price at the date of exercise.

At the date of disposal of the shares, Capital Gains Tax (currently 33 per cent) will be charged on any gain arising between the purchase of the shares and the disposal of the shares. The gain equals the proceeds on disposal of the shares less the market value of the shares on the date of exercise (subject to an individual’s annual exemption of €1,270).

From the company’s perspective, although the obligation to pay all taxes and charges lies with the employee, there are some reporting requirements in terms of notifying the Revenue Commissioner when share options are granted.

Alternatives to consider

It should be noted that share options are just one way to incentivise employees and potentially give your company the edge in attracting key talent. But share options may not suit every company. Bear in mind that a sales commission based approach may be more appropriate for your company, where you are compensating employees for increased sales effort. Milestone based bonuses could also be an option.

Attracting the right people to your company will probably involve a combination of financial and non-financial incentives. Share options provide just one possibility for you to consider.