​Why I turned down a £5,000 raise and should you do the same?

At the start of 2017, my company offered me a £5,000 pay rise to recognise my increasing value to the firm. To everyone’s surprised, I declined the raise.
 
Some of you may already be thinking that I was barking mad as not many people would say no to free money. Well I didn’t turn down the pay rise entirely as instead, I asked to be given more stock (or share) options.
 
Stock options is a simple agreement between you and your company which states that you can purchase a predefined number of shares at a predetermined price (strike price) under certain scenarios (usually sales or public listing, known as liquidity events). Normally the strike price is significantly lower than the liquidity price because the company would have grown in revenue and profitability (hence creating value) between the issuance of the option and the liquidity event, which is usually a 2-5-year time horizon. This way you make a handsome profit on the difference.
 
Here’s why I did it.

1. A huge chunk of my salary increase would have gone to the taxman.

The £5,000 raise was equivalent to £417 per month nominally, however once tax and national insurance (a form of taxation used to fund welfare in the U.K.) contributions were taken off, I would have been left with £242, a 42% reduction (or marginal tax rate). This meant that I would have been toiling hard for the taxman for the first 5 months after the raise, before receiving a penny myself.
 
Share options are taxed only on its gains once it “liquidates” (i.e. the company got bought out or became publicly listed) as it is treated as capital. It is taxed at a much lighter rate of 10% under the Enterprise Management Incentives (EMI) Scheme. Furthermore I could defer the tax liability until the point of liquidation, which could be a few years down the line, meaning there would be zero cash flow impact on my person finance.
 

2. Share options could offer vastly greater return than your salary.

Share options are essentially instruments of delayed gratification. Instead of receiving an immediate cash injection of £5,000 in the form of the pay rise, I opted for a higher value share options but accepted the fact that I might not see these options becoming cash for a few years (thus unable to immediately enjoy the utility it brought).
 
Furthermore I accepted that future was unpredictable and these options could potentially be worthless if my company ran into any trouble. However on the plus side, if the company did succeed, then the value of of my options would increase by 3-5 times at least.
 
So I was left with 2 simple choices:
  1. Accept £5,000 cash (£2,904 net) now with 100% certainty;
  2. Accept the potential to have £30,000-£50,000 (£27,000-£45,000 net) worth of cash in 3-5 years’ time but risk receiving less or none.
I didn’t desperately need an extra £242 per month. The thought of working for the taxman for 5 months just to justify the pay rise really didn’t appeal to me. Furthermore I enjoy taking risks financially and the only downside was forgoing £2904 of cash for potentially 5 times the return. So obviously I chose the stock option route.
 

3. Share options save your company money and aligns your incentives.

This naturally brings me to the last thought about why I accepted the options: it aligned my interest to my company’s whilst conserving cash.
 
The company that I worked for was at what many would call the start-up stage. We were a young firm whose average age was in the late 20s. Like any other young businesses, whilst our ambitions knew no bounds, our cash balance was very finite. Thus every penny that went into my pocket as salary or bonus (and the taxman’s coffer) was a penny that could have been spent on growing the company. On the other hand, share options had zero cash flow impact and came with an extremely favourable tax treatment, therefore it made natural sense for me to forego the raise.
 
A natural consequence of taking a stake (i.e. ownership) in the company that I loved was that my interest became aligned with that of the company’s. I genuinely care about every aspect of its business and was willing to go to heaven and earth to strive for the best of the company. It truly became a job that I adored.
 

Should you do the same?

Here’s a handy checklist on whether you should turn down the next pay rise asked for share in the company you work for instead. If you answered an affirmative yes to all of the questions below then you should definitely consider it.
  • Do you need the additional monthly cash? (Remember needs and wants are two very different concepts)
  • Does your company have a positive long term prospect?
  • Do you love your company?

Wrap up

I turned down a £5,000 raise when I was 27 and chose a far riskier stock option instead because:
  • I didn’t need the additional cash flow.
  • I was convinced on the fundamental outlook of my company and the multiple returns I could make on my stock options compared to a single pay rise.
  • I loved my job and the company I worked for.
If you were offered the same choice, what would yours be? Please comment away.