5 things you need to know about share options

Jo Nisbet | 11 Sep 2015

INSIGHTS

1. What are share options?

Share options give a third party a right to acquire shares in a company at some point in the future at a previously agreed price. It is a contractual right for someone to become a shareholder – they are not a shareholder when the share option agreement is entered into. There are approved tax-favoured and unapproved non tax-favoured share option schemes. Unapproved plans can be flexible – there are no statutory provisions governing their terms. However, as the name suggests, unapproved share options do not attract any tax benefits. Whilst there are many types of share options which attract favourable tax treatment, Enterprise Management Incentives (EMI) share options are the most common for early stage businesses.

EMI share options are specifically targeted at relatively small, higher-risk trading companies.

2. Why do companies use share options?

The key reasons for share options are typically financial and motivational. Employee share incentive plans can be a tax-efficient way to remunerate employees. They can therefore help reduce employment costs. They are used to recruit, retain and motivate employees and improve staff performance. Share incentives can also help to align the interests of senior executives with those of shareholders by encouraging them to consider shareholders’ interests in managing the business. They can also help private companies with succession or exit planning.

3. Who can be granted share options?

Share options can be granted to anyone that the directors see fit, for example consultants, directors, Entrepreneurial Spark etc. However, to be eligible to be granted an EMI option, an employee must work for the company for at least 25 hours per week, or if less, 75% of his working time. You should seek specific tax advice if you are considering EMI share options.

4. How many shares and at what price?

Before entering a share option arrangement, careful though needs to be given to the amount of shares which are available under the option. Future investors may be deterred if the share option is over a large percentage of the share capital. A share option agreement which is over a set number of shares, as opposed to a percentage, may be more attractive to potential investors so please be mindful of this when liaising with an individual. Five shares and 5% could be vastly different at the time the option is exercised. The exercise price of option shares can be set at any value, however tax advice should always be sought in respect of valuations.

5. When can an option be exercised?

There are limited restrictions on the exercise provisions that apply to share options. This flexibility means that share options can be used for exit-only arrangements as well as for options exercisable at the end of a performance or vesting period. Companies may find it useful to link the ability to exercise to performance targets. For example, the share option may become exercisable when turnover reaches a certain level, when a new product is shipped or when a certain stage in the development of a product is reached. Share options can be linked to an individual’s own performance and can be personal to them relating to their own actual targets.