A question of scale

The Organisation for Economic Co-operation and Development (OECD) defines scaleups as those companies with a minimum of 10 employees that have been growing over three consecutive financial years at an annual rate above 20% in terms of turnover or number of employees. 

Scaleups are the slightly older brother of startups, being more mature, more experienced, better organised and with a proven business model that is scalable.

Scaleups typically operate a rigorous employee equity programme and understand the importance of having a large employee equity pool to recruit, retain and incentivise staff.

Employee equity

Employee equity is about an individual owning or having the potential to own, a bit of the scaleup that employs them. 

Becoming a part owner encourages achievement, increases employee retention, attracts top talent, drives strategic execution of the business plan and creates an alignment of interest between effort and reward. 

It is the purest expression of converting human capital into financial capital to build long term wealth. 

But, as an employee equity holder in a scaleup, self-regulating the emotional roller-coaster of achieving long term wealth creation is hard. 

Part fear, part greed, part troublesome doubt, the employee equity holder has to balance the downside risks for their career and finances if things go wrong. If things go right, there is the potential for considerable upside, both financially and from being part of something new and exciting.

However, absent a sale or IPO of the scaleup, it is not easy for employee equity holders or indeed the founders, owners and investors, to convert their financial capital into actual cash. 

And given the current stand-off between buyers and sellers over company valuations and with private companies staying private for longer, what happens if there is no sale or IPO on the horizon? How do employees and others, take money off the table? How do they de-risk? How do employees more effectively monetise their human capital?

Synthetic exits

Currently, if UK scaleups want to help employee equity holders to realise value, they have to resort to engineering some some sort of synthetic exit for them.

A synthetic exit is essentially a manufactured liquidity event that is not a sale of the company or an IPO. It is a substitute for a traditional exit event by using someone or something to be a buyer of last resort, often through the creation of an internal market. 

This could involve funding an employee benefit trust to administer such a market or a strategic investor or corporate shareholder agreeing to buy the employee equity during pre-determined liquidity windows.

(Note that issuing company buy-backs have superficial attractions from a tax perspective as there is the potential for any sale proceeds of employee equity to be taxed as a distribution not as capital. This is sometimes known as the 'dividend tax' trap.)

Creating an internal market requires the scaleup to navigate the various legal, tax and other technical considerations such as price discovery. Ultimately it requires someone or something prepared to fund the transaction.

Enter the London Stock Exchange to help plug the gap. 

A new liquidity market

The LSE is keen to create a new liquidity market for employees / founders / owners etc. through a new platform called an Intermittent Trading Venue. The platform will enable companies to stay private but provide liquidity at predetermined intervals through the "...controlled and efficient mechanism of a stock exchange auction."

In practice, the usual legal, tax and technical considerations relevant to a transaction in private company shares are still going to be relevant. 

But, anything that helps to make private capital flow more freely, that more effectively matches buyers with sellers, which facilitates better price discovery and creates genuine liquidity in otherwise illiquid stock, is a welcome development for both scaleups and their employee equity holders.