Employee Share Scheme / Options / SAFE / Incentives

A. What is an Employee Incentive Scheme?

The purpose of an employee incentive scheme is to recognize and reward employees for their hard work. Incentive mechanisms vary according to the rewards given, but they are usually designed to encourage employees to work towards specific goals. Many companies use employee incentive programs to create high productivity and employee performance, improve morale and retain employees. It also provides commercial advantages to the growth of the company. Without some incentive mechanisms, it is difficult to maintain control over the development of the company.
The first priority is to create a company with good morale and productive employees, which will bring rewards in terms of productivity and retention. However, it is important to align properly the incentive with the value of the company. Employees should devote their energy to their work, not the rewards they may receive.

Listed companies with a clear valuation of shares tend to have an employee share scheme or an employee option scheme. Whereas a startup with indefinite valuation may want to use a Simple Agreement for Future Equity (“SAFE”).

B. How to set up an Employee Incentive Scheme?

1. Factors to Consider

To begin, you will need to consider the following factors:

• Who are you distributing the equity to? To employees, non-employees, or both?
• Should equity is given to employees immediately, or do you want others to buy it at some point in the future?
• Do you need to reach performance milestones before issuing equity?
• If the employee leaves the company prior to distribution, would they still be entitled to the equity?
• How big is your company? Is there already a valuation on the company? What is the size of the team?

2. Set Goals

What would you like to achieve from the scheme? Do you want to increase revenue or profit? Increase in valuation to sell the company at a better price? Do you want to increase employees’ satisfaction and reduce their turnover? Have a clear idea of the final goals so that you can better judge whether it is successful.
Are you setting these goals for the team or for individuals? Who should be included in the scheme? Everyone or employees at a certain seniority level or above? It is important to make everyone feel involved, but make sure you create different programs for different people or teams. This will ensure that no one feels alienated and that everyone can get the most benefit from their plan. As for the goals themselves, make them challenging but achievable so that people are neither discouraged nor bored.

3. Timeframe

It is important to set a clear timeframe with employees to achieve these goals or performance targets in the incentive plan so that they know when they will need to complete the work. Creating a clear timeframe not only allows everyone to participate but also allows everyone to assess the amount of work that needs to be done within a certain period of time. Depending on your goals, you may need to divide a long-term goal into a series of short-term goals to maintain the momentum.

4. Incentives

Decide on the incentives to thank the team. Incentives are not necessarily based on shares or equity but can be meals, holidays, awards, additional leave, bonuses (e.g. cash bonus and performance bonus), or even tailored for each individual separately. Money rewards are a simple incentive, but it is important to ask your employees what they want. You can give them some choices, let them choose their favourite incentives. By choosing an incentive they really want, you can ensure that they have sufficient motivation to work hard.

5. Measure

In order to know whether your plan is effective, you need to design some methods to measure its success. You can use numbers to measure sales, profits, and profit margins through business records. You need to ensure that your measurement method is specific to your business and plan in order to accurately determine whether it is worthwhile. Remember that it is also important to ask the employees who participated in the plan what they think and whether they think the plan enriches their work experience.

C. Employees Share Scheme

An employee share scheme is to give employees actual shares immediately, as opposed to an employee share option scheme which is to issue options that can be exercised sometime in the future (see below).

There are generally two types of schemes:

• Ordinary shares scheme - This type of scheme refers to issuing company shares to employees. These can be new shares or shares held by business owners and investors.
• Growth shares scheme – This type of scheme is the same as ordinary stocks, except that there is a “hurdle price” given at a small premium to the company’s current valuation. This means that the employees will only participate in the future increase in the value of the company.

The features of an employee share scheme are:

1. Become shareholders: The employees become shareholders immediately and have real ownership of the company.
2. Issue of shares: The shares are issued in the name of the employees who are entitled to voting rights and dividends.

D. Employee Option Scheme

An employee option scheme allows recipients to purchase shares at a pre-approved price (exercise price) later. The options are only valuable if the value of the shares is above the exercise price and are worthless if the value is below the exercise price. This creates an incentive for the employees to work hard to create value for the company. On the contrary, it is sometimes argued that it focuses on the management and employees on the short-term share performance of the company as opposed to long-term goals.

The features of an employee option scheme are:

1. They only become shares after they are exercised so that there is no dilution effect until exercise.
   
   
2. The option holders are not entitled to voting rights and dividends.
   
   
3. Options may incur tax liability when exercised. The tax liability could be a huge burden on businesses that are more successful (the difference between the value and the exercise price).

E. Simple Agreement for Future Equity (SAFE)

SAFE is a financing contract that startups can use to incentivise employees or to raise funds in seed financing. This tool is seen by some as a substitute for an employee share scheme or convertible notes that are more beneficial to the founders.

The basic idea is that the holder of SAFE is an early employee/investor whose stake in the company will be based on the valuation in the future pricing round of the company. It gives the employee/investor the right to acquire equity in the company on certain trigger events, such as:

• future round of equity financing led by venture capital funds or private equity; or
• when the company is sold.

The price for the SAFE holders will be lower than those of the investors or buyers in connection with the financing or the sale. A discount rate and a valuation ceiling will be set under SAFE.
SAFE is similar to a convertible note except that it is not a debt instrument, so the company is not liable to repay any principal or interest.  In addition, SAFE does not have an expiry date and can be outstanding until the conversion event occurs.