24 Sep
2015

Share options for staff - incentives for the longer term

A share option awarded to an employee or associate of a company provides the option holder with the right to purchase a number of shares in the company, at a given price, on or after certain dates. Generally, options are conferred to incentivize the holder to continue working or partnering with the company until the business is sold, i.e. an ‘exit.’ The holder is motivated by the fact that they have a ‘stake’ in the company, over and above any regular earnings or revenue from it. The company will usually formalise the option by documenting it in an option contract which will include the necessary terms and conditions.

Some of the key terms used when discussing options are as follows –

‘Grant’ – this is when the option rights are awarded

‘Vest’ – this is the point at which the option holder can actually exercise their option

‘Exercise’ – this is when the option holder uses the option to actually buy the shares

‘Exercise price’ (or strike price) – the price per share paid under the option

So for example, on 1 June 2015 Kate is granted an option to buy 100 shares at £1 each in Company X. The option vests one year after the grant i.e. on 31 May 2016. She exercises the option and buys all the shares on 1 June 2016. Kate is then a full shareholder in the company, rather than just an option holder. Two years later the company is sold and her shares are worth £10,000 so she has made a gain of £9,900. Under an EMI scheme she might have to pay only 10% capital gains tax on that gain.

Share options can provide the potential for a medium to long-term capital gain, possibly sizeable if it’s a high growth business whose valuation increases substantially. Companies can structure share options in all sorts of ways, for example so that they can only be exercised when the business is sold. In most cases, to facilitate their own cash flow, option holders will buy and then sell their shares on the day of an exit, so that they end up with the net gain on the day. Option schemes do not generally require holders to buy the shares prior to an actual exit event.

For non-employees, what’s known as an ‘unapproved scheme’ can be used. This will be established with many similar terms and conditions as an employee scheme, but an option holder would only be chargeable to capital gains tax (or chargeable gains if a company) rather than PAYE and NICs. An EMI scheme, essentially, ‘converts’ PAYE and NICs to lower rate capital gains tax for employees. We can prepare unapproved schemes as well as EMI schemes.