How many shares should I give my employees?

Private company owners frequently ask what percentage of share capital they should use in their employee share plan.  In other words, how much dilution is reasonable for shareholders to accept.

The truth is, there’s no right answer to this.  But here are some pointers to help you decide how generous – or not! – you might be when you’re setting up a share plan for your employees.

Rule of thumb – 10%?

A starting point for a sensible level of share capital is “about 10% for everyone”.  This is based in part on the Investment Association’s Principles of Remuneration (IA Principles).  These are guidelines followed by listed companies. Private companies don’t have to follow these rules, but the 10% rule is reasonable, and shouldn’t scare the horses.

How much for key staff?

That 10% figure applies to shares used for all employees. However, private companies are much more likely to reward a few key staff with shares or options than to extend share ownership more widely. 

The IA Principles used to suggest that 5% was a reasonable level for executive plans, but a recent update has removed that limit.  On that basis, if a private company wanted to establish a share plan that delivered up to 10% of the equity for just one or two key executives, that would still be in line with current best practice for listed companies.

Commercial reality

In reality, the IA Principles aren’t that relevant to the decisions of private company owners.  If you’re making a key hire and the demand is for a 10% equity stake, or even higher, then there’s absolutely no reason why that can’t be delivered.  It’s all down to negotiation and commercial reality.  Most importantly, you’ll need to balance the requirement to recruit and retain the best people, with protection for the current shareholders.

How to protect existing shareholders

Thinking about the percentage of equity to use is important.  However, whatever level of equity you decide on, there are plenty of other ways to protect shareholders’ interests.  For example:

• If the plan is to sell the company in the short to medium term, what’s the minimum (or indeed, maximum) financial reward that you want your key hire to receive?  You may wish to put a cap on the payout, irrespective of the number of shares held.
• You might be comfortable giving up 10% of the sale proceeds, if your key person has helped the company achieve a certain value.  But you don’t have to give up 10% of your dividend rights, or 10% of your votes.  You can create a different share class for your share plan to protect your interests before a sale happens.  Alternatively you can use options, rather than shares, that don’t give any dividend or voting rights, and will only deliver value on an exit.
• You might grant options over up to 10% of the equity – but that doesn’t necessarily mean the key person will get 10%.  You might attach performance conditions so that the options only vest in part, depending on whether those conditions are met.
• And don’t forget that if your key person leaves, you can put in place leaver conditions that mean options lapse, or that their shares can be bought back from them – with the price they receive depending on the reason for their leaving.

Next steps

How much you’re prepared to give away, and when, and how to deal with leavers, are all fundamental aspects of share plan design, especially for private company owners.   Here at RM2 we can help you decide what the right level of equity is for you and your employees, and work through all the other questions you will have before making awards to your employees.

For a free consultation, email us on enquiries@rm2.co.uk and one of our consultants will be happy to speak with you.