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Five key decisions before you use employee share schemes

Averill Dickson | June 30, 2015
In tech hotspots such as Silicon Valley, employee option schemes are commonly used in high-growth companies to incentivise talented people. Here is a guide to find out whether this option is right for your company, and what are areas to watch out for.

A shortage of skilled IT workers in New Zealand is commonly cited as both a barrier for growth for businesses in the technology sector and a key business challenge for IT departments.

The Ministry of Business, Innovation and Employment's 2015 ICT Sector Report, released in May, reports a component annual growth rate for jobs in the software and IT services sector of 8.6 percent from 2010 to 2014. More businesses in this sector (84 percent of businesses) report vacancies, and that vacancies are hard to fill (53 percent of businesses), than in any other sector of the economy.

While there are a number of Government and industry initiatives that have been established to address this issue, if your business is facing a hiring crunch, is there anything that you can do to attract, and retain, talent to your business?

One way to both attract and retain talent is to give employees an opportunity to participate financially in the growth of your company. In tech hotspots such as Silicon Valley, employee option schemes are commonly used in high-growth companies to incentivise talented people.

Share options give employees an option, but not an obligation, to buy shares in the company at some time in the future, at a price agreed now. When the options are exercised, employees receive the benefit of any increase in value of the shares in the company, but without having to outlay any upfront cash, or taking the risk that the value of the shares might diminish.

Recent changes in New Zealand's legislation have made it easier for private companies to offer employee option schemes here.

There is a tendency in New Zealand to only offer options to senior management. In Silicon Valley, participation tends to be much more widely spread.

If you're interested in setting up a scheme, here are five things you should consider:

1. What sort of businesses should use option schemes?

The key financial benefit for employees arises from growth in the value of the underlying shares. Option schemes therefore work best for high growth businesses. There needs to be some mechanism, in the future, for the employee to realise that value. If an employee exercises her options, but can't then sell the resulting shares, the only financial benefit is a possible ongoing dividend stream. Employee option schemes are therefore less useful in businesses where there is no intention for the majority owner(s) to exit, (for example, closely held, long term family businesses).

2. Which employees should I offer options to?

There is a tendency in New Zealand to only offer options to senior management. In Silicon Valley, participation tends to be much more widely spread, with it being common for early-stage companies to assume they'll be giving up 10 to 15 percent of their shares in options.

 

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