Table of Contents
In Short
- Share options let employees buy shares at a future date for a set price.
- They’re commonly used by startups to attract and retain talent.
- There are different types of share options, each with unique benefits and tax implications.
Tips for Businesses
Share options can be a great tool for incentivising and retaining staff, especially in startups. Before offering share options, it’s essential to understand the tax implications and ensure you have the right agreements in place. Seek legal advice to make sure your scheme is structured correctly.
As a startup founder, understanding share option schemes is crucial for your business’s sustained success and growth. Share options can be powerful tools to attract and retain top talent, align employee interests with your company’s goals, and raise capital. However, without a clear strategy and proper legal framework, share options can lead to disputes, dilution of ownership, and unintended tax-related consequences. This article will explain what share option schemes are and their legal implications. By addressing these issues, you can avoid common pitfalls and ensure your equity distribution system is fair for all stakeholders.
What are Share Options?
Share option schemes give employees the right to buy their company’s shares at a fixed price, known as the exercise price. Employees can exercise their options after a certain period or upon meeting particular conditions. For founders, share option schemes are a way to share the company’s growth without immediate cash outlay.
Conserving cash is crucial in startups, especially in the early stages. Share options allow you to offer competitive compensation without depleting your valuable cash reserves. By granting options as part of remuneration packages, you can attract talented employees willing to invest their time and skills in exchange for potential future rewards.
Legal Implications of Share Options
Understanding the legal implications of share options is essential to avoid potential employee disputes and snags in your equity management approach. This section highlights some key areas you should consider.
Continue reading this article below the formCall 0808 196 8584 for urgent assistance.
Otherwise, complete this form and we will contact you within one business day.
1. Understanding the Share Schemes
Researching each share scheme is crucial to choosing the right one for your startup. In the UK, companies can grant share options through tax-advantaged schemes such as the Enterprise Management Incentive (EMI) scheme or the Company Share Option Plan (CSOP).
Each scheme has different eligibility requirements. You can also grant options through non-tax-advantaged arrangements.
2. Documentation
Proper documentation is vital when granting share options. You should ensure you share a legally binding agreement with each option holder your company grants share options. An explicit share option agreement helps set the terms of the arrangement and mitigate the risk of disputes arising.
A share option agreement should clearly outline aspects such as:
- the terms and conditions of the agreement;
- the number of options your company has granted;
- the exercise price; and
- any performance conditions.
Seeking legal advice about your share option arrangement is a great idea. A lawyer can help you:
- choose the right arrangement for your startup;
- draft a share option agreement; and
- identify and mitigate risks associated with your company granting options.
3. Valuation and Pricing
The type of options arrangement you choose can have significant tax implications. For example, the EMI and CSOP schemes allow employees to exercise options without paying income tax or national insurance contributions, provided their exercise meets certain conditions. One such condition is that employees must buy their shares at or above the market value when your company granted the options.
Due to the tax implications, the exercise price of the share options must reflect the fair market value of your company’s shares when you grant them. Setting the exercise price below the market value can lead to such implications even if you opt for a tax-advantaged scheme.
Before you issue options, you should seek a professional company valuation. If you plan to use the EMI or CSOP scheme, you should also seek HMRC approval of your valuation. This approval will provide certainty over tax treatment and mitigate the risk of potential legal disputes further down the line.
4. Dilution of Ownership
Granting share options will dilute the ownership of existing shareholders. As employees exercise their options and acquire shares, the ownership percentage of existing shareholders decreases.
It is vital to carefully plan your company’s equity distribution system to manage the dilution risk. Your planning should involve setting aside a specific pool of shares exclusively for granting options, known as an options pool, and communicating this plan to existing shareholders. Beyond this, you should also monitor the impact of dilution on shareholders’ control and voting rights. Effective planning and monitoring is crucial to maintain a balanced ownership structure.
LegalVision’s Startup Manual is essential reading material for any startup founder looking to launch and grow a successful startup.
Key Takeaways
Share options can be a great way to attract talent and align employees’ interests with your company’s goals. However, this practice can lead to disputes, ownership dilution, and tax issues if you lack a clear strategy for granting share options and a clear legal framework.
As a founder, you should document your granting of share options through share option agreements. It is also crucial to be aware of the risks of equity dilution and to develop a clear equity strategy. Setting aside an options pool, a portion of equity you will grant as part of your employee options arrangement, is a good idea to mitigate this risk. You should also seek a professional valuation of your company before granting options and seek HMRC approval of the valuation. HMRC approval helps to provide certainty over tax treatment upon exercise.
If you would like legal advice about implementing a share options scheme in your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Share options give employees the right to buy company shares at a fixed price, known as the exercise price. Employees can exercise their options after a certain period or upon meeting certain conditions.
Shares represent ownership in a company and provide shareholders with voting rights and dividends. On the other hand, share options give individuals the right to purchase shares at a predetermined price in the future. Unlike shares, share options do not confer immediate ownership.
We appreciate your feedback – your submission has been successfully received.
