Employee Options: an exclusive Q&A with Stephen Morana 

Prior to ZPG, Stephen spent a decade at Betfair as the CFO, helping the business scale from early stage venture to what is now a FTSE100 business. He was interim CEO for his last year there in 2012. Stephen is a board member and audit committee chairman of boohoo.com the fast fashion brand that is now valued at around £1.5bn and also GVC the FTSE250 global gaming business who operates under brands such as bwin and partypoker.

At Octopus, Stephen works closely with portfolio companies to help them professionalise their process, identify gaps in their team and plan for appropriate financing structures as Companies grow.

“Why have an option pool? In your businesses, did you stick to one approach?”

To me, it’s all about being able to hire and retain the key staff you want, plus the cultural side of everyone owning a stake in the business. In a perfect world, all staff would have some sort of stake in the business, but this is easier said than done. The problem with everyone getting something is twofold: (1) a significant reduction in the overall option pot — less to go around and; (2) an administration burden for the business which is not to be underestimated.

This latter point really shouldn’t be discounted: EMI option grants are the best method of allocating stock to employees — but need HMRC approval. This approval is only live for a short period of time and needs to keep on getting refreshed for newer staff to qualify — complex vesting schemes can mean constant questions as to who has what, etc.

I think it also depends on the stage the company is at. You can begin by using options as an incentive for hiring/promotions, and evolve to more of an annual grant based on performance. Longer term you want senior management on an annual LTIP scheme or something of that ilk, where they are focused on longer term goals and incentivized accordingly, but I think they are too sophisticated for earlier stage businesses.

“You have worked on businesses at every stage. Have you only ever used EMI schemes?”

Sadly, EMI options don’t last forever. After that, an approved share scheme is very limited, meaning that most options are granted with a significant tax burden attached. The company also has the ability (which you want to be sure it takes) of passing the employer’s national insurance burden onto employees for unapproved share option grants. This was brought in to protect companies from being hit with huge tax liabilities on option exercises. At one of my companies we lost our EMI status after a big investment and the impact on staff is quite significant when looking at the tax burden. I would recommend trying to get most of the grants done whilst EMI status is in place. Also, gains made on share options grants are deductible against corporation tax which is a big benefit to businesses.

“My biggest single frustration with share schemes for staff is the fact that most people have no real idea of the potential of what they have…which in a way defeats the whole purpose of putting the scheme in place.”

One way we found at one of my companies of enabling everyone to feel they had a stake was through a SAYE scheme. I wouldn’t push this for all types of business (loss making, still a significant risk of failure etc.) but it’s an HMRC approved scheme so it means good tax breaks, and because people are contributing some monies themselves each month they really understand the potential value of what they have. My biggest single frustration with share schemes for staff is the fact that most people have no real idea of the potential of what they have, which means they aren’t valuing them when thinking of their package, which defeats the whole purpose of the scheme being there to ensure staff are retained and feel motivated. I have witnessed the farcical situation of a number of relatively senior staff requesting to come out of a long-term incentive plan which could easily have been worth six figures to them, for a relatively small increase in annual cash bonus.

In terms of scheme rules, I don’t think there is a perfect answer, it’s just about understanding the implications. I would always push for simplicity.

“When would you advise establishing an option pool? What have you learned about allocating and granting options?”

You should push to get an option pool in place as early as possible and management have to understand that this is a pool for the next 5 or so years, so it is not to be thrown around. At one of my companies, we gave away 10% of options within 18 months and then had huge issues around putting a new pool in place for future grants. It is interesting to refer to PLC rules, whereby a company can only issue 10% of stock via option schemes over 10 years.

I think it makes sense to put in place a good control process at board level over option grants, with all grants requiring board approval. Management can tend to be far too generous (as it’s non-cash), or far too stingy which can cause significant issues further down the line.

“What has worked for you with regards to vesting and leavers?”

In one of my companies we started far too generously: 3 years vesting with monthly vesting cycles, and the employee could keep the options that had vested when they left at any time. We then swayed totally the other way: 3 years but you had to stay all 3 years to get anything, then if you left you had 90 days to exercise or you lost them.

I personally don’t like monthly vesting as it’s too much of an administration burden keeping up to speed with this. I personally favour a longer cliff — say 4 years vesting with a 2 year cliff and then annual vesting after. Sounds a bit onerous but it’s about driving for the medium term, not giving staff an incentive to jump ship, especially if you need to replace them and will need new options for that.

I do like forcing staff to exercise when they leave as well. Options are a huge benefit in that you get the upside without any downside risk. Once someone has left I am comfortable saying they have to now stump up if they want to share in future upsides. Many people disagree with this and think it’s too onerous though.

“What is your biggest learning about employee schemes?”

Any company that puts in a stock scheme for more than a few people really needs to focus on how it is implemented and the ongoing communications around it. In many instances (and I appreciate this a huge generalization) you end up with a finance or legal function responsible for its implementation, and they aren’t the best at communicating the scheme, and a HR function who executes it across the business, and they don’t understand the full details of the scheme. An employee scheme needs a proper owner who really understands it and is passionate about employees also understanding and being excited about the potential financial upside.