Management shares and employee share option plans: keep control while rewarding staff (UK)

Do you want to keep control of your company while attracting investors? Are you thinking about incentivising your team by giving them shares? Two tools do most of the work here: management shares, which give founders enhanced voting rights, and employee share option plans, which give staff the right to buy shares at a fixed price in the future. Here is how each one works, and the three things I tell company owners to get right when putting them in place.

What are management shares?

Management shares are a special class of shares that give the holder enhanced control over the company.

Ordinary shares typically carry one vote per share. Management shares can carry more than one vote per share, for example 100 votes per share. That difference is the whole point.

Here is how founders use them in practice. The founders and managers of the business hold management shares with, say, 100 votes each. The company then raises equity finance by issuing a different class of shares to investors. The investors get their shares and their economic rights, but the founders keep control of the important decisions about the company because their votes outweigh everyone else's. The result is that the business can raise capital without the founders handing over control.

What is an employee share option plan (ESOP)?

An employee share option plan is used to incentivise and retain your best people. It gives employees the right to buy shares in your company at a future date for a fixed price.

The key features are:

• The price is fixed today. You decide the price now, and it can be as low as £1 per share. The employee benefits because they are buying at a discount to what the shares are worth when they exercise.
• The option is exercised later. It can only be exercised in the future, either by a specific date or when a specific milestone or goal is met.

That structure does two jobs at once. First, it helps you retain people. An employee knows that in, say, two years they get to exercise a very good option to buy shares at a discount, and that the following year they will have a further option to buy more shares at a discount. Leaving means walking away from that.

Second, it helps you drive performance. You can attach the right to buy shares to milestones and goals being met rather than just the passage of time. For example, you might grant a share option plan to a salesperson that says: if you secure a certain amount of sales revenue within the next two years, you get the right to buy more shares at a lower price. Time-based and performance-based options can sit side by side in the same plan.

The reason options work better than simply handing over shares on day one is that nothing is given away until the condition is met. If the employee leaves after six months, or never hits the target, the option lapses and the company has lost nothing. If they stay and deliver, they buy in at the agreed price and become a shareholder who has earned it.

Using management shares and share options together

In practice the two tools are usually combined. The founders hold the management shares with enhanced votes. Investors hold a class of shares with the economic rights they have paid for. Employees hold options over a further class, exercisable over time or on results.

That structure lets you do the three things most growing companies want at once: bring in outside capital, reward the people who build the business, and keep the final say on the decisions that matter. The tips below are about making sure the paperwork actually delivers that.

Share rights: articles vs shareholders' agreement

My first tip for company owners implementing these strategies is to set out the rights of the different classes of shares in your articles of association, not just in a shareholders' agreement.

The reason is the threshold for changing them later. A company's articles can be amended by special resolution: as long as holders of 75% of the voting shares are in favour, you can amend the articles. A shareholders' agreement, on the other hand, can only be amended by unanimous consent. Everyone has to be on board. That is a much higher threshold, and as the number of shareholders grows, especially once employees hold shares, unanimity becomes hard to achieve.

Putting the share class rights in the articles keeps the structure workable as the company grows. For more on the relationship between the two documents, see does a shareholders' agreement override the articles?.

Don't scare off investors with founder control

My second tip is to strike a balance and not get carried away when drafting your articles of association.

It is tempting to load the management share class with every protection you can think of. But if the articles are too one-sided, too much in favour of one class of shares, that can scare off potential equity investors. An investor reading articles that give them no meaningful say and no protection will either walk away or demand changes before they invest. A good balance needs to be struck between founder control and terms an investor can live with.

Bad leaver provisions for employee shares

My third tip, and the one that matters most if you are giving shares to employees, is to include bad leaver provisions in your articles of association.

Bad leaver provisions allow the company to buy back the shares it has given to an employee if that employee leaves on bad terms, for example because of gross misconduct. Without them, an employee who is dismissed for serious wrongdoing could walk away still holding shares in your company, with all the rights that go with them, and you would have no mechanism to recover them.

Put simply: if you are going to use shares to reward people, you need a way to take them back when the relationship ends badly. The time to put that mechanism in place is before the first option is granted, because adding it afterwards means persuading the very shareholders it would apply to.

So that is how management shares and employee share option plans work together to protect founders: one keeps the votes where you want them, the other rewards the people who help you grow, and the articles tie it all together.

Next steps

Decide what you want each class of shares to do: enhanced votes for founders, options for employees, straightforward economic rights for investors. Then have a corporate solicitor draft bespoke articles of association that create those classes, set out their rights and include bad leaver provisions, and prepare the option agreements for staff. To see how the classes themselves are created, watch how to create different classes of shares, and for paying people in shares more generally see sweat equity explained.