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Attracting top talent to your company is one of the most important keys to success. A talented, motivated team working together towards common goals is fuel to thrive. Share option schemes have become a common and effective benefit for startups to attract, retain and motivate the best employees.
In this article, we cover what you need to know about share option schemes from the experts at SeedLegals.
Share option schemes allow you to give company equity to employees, advisors, consultants and freelancers (you can even give them to customers and influencers too).
Share options aren’t quite shares - they’re the option to purchase shares at a later date. Team members who receive share options can exercise the options at a pre-agreed point to convert them into shares and own equity in the company. The shares can be bought at a fixed price, usually a nominal amount or significantly less than the market price. This means that options recipients don’t have to make a financial investment upfront.
Usually, the option holder doesn't receive their full allocation of options in one go. Instead, they earn them over a period of time or when certain milestones are achieved. This is known as 'vesting'. This makes them a great incentive for employees to work together towards common goals, knowing that they’ll be rewarded when they hit certain milestones. Share options can be offered as a benefit to employees in addition to their salary and other benefits.
Example:
Alex is granted 10,000 share options. They’re given at a nominal value of £0.001 per share. Her options vest over three years and then become available to exercise (convert into shares). Alex buys her shares for £10, even though in the market they’re worth £100,000. Five years later, she sells her shares for £150,000.
Different tax treatments will apply to the share sale depending on the country the option holder pays tax in, so make sure you and your options recipients understand the relevant tax implications.
A share option scheme is a formal plan your company can adopt to award share options to team members. Share option schemes are great because you can design your own. By customising the terms, you can make it work in the best interests of your company and your employees.
To give share options to team members, you set aside some company equity (known as an option pool), set up a share option scheme and distribute the share options. You decide on the rules of your share option scheme, mainly how the shares will vest and when they can be exercised.
Vesting is the period in which share options are being earned. You can choose when and how that vesting period ends. Some companies choose a time-based vesting schedule while others go for a milestone-based vesting schedule.
Vesting by milestone
With milestone vesting, shares in a company are granted only when pre-established milestones or criteria are met. This type of vesting schedule can work well for advisors and consultants because they’re usually with a company for a shorter period of time and are there to fulfil specific deliverables.
Vesting by time
For employees, vesting over a number of years is standard, typically either:
“Companies like a vesting cliff because it encourages recruits to stay for at least the length of the cliff. But sometimes employees find a cliff off putting because they worry that the company is luring them with share options only to let them go just before the cliff ends.
Overall, it’s about trust. As an employer, you offer share options to show your team you trust them to work hard to help you build the business. Employees need to choose a company where they can trust their managers - not just so that they can feel confident they’ll get their options, but also to have a positive experience that makes them want to stay long enough to earn them. ” - Mo Saed, Share Option Schemes Expert, SeedLegals
To learn more about vesting, read Vesting, Milestone or Exit-Only: which share option scheme is best for you?
Exercising is when share options convert into shares. When you give your team share options, they’ll earn more each month (called vesting) and once the employee has enough share options that have vested, they can exercise those options. To exercise their options, they pay the previously agreed exercise price to turn those share options into shares and become a shareholder in the company.
When someone wants to exercise their options, the following needs to happen:
When you design your option scheme, you decide when holders can exercise their options. Allowing exercise anytime gives your holders flexibility. However, depending on the rights you assigned to those share options, when employees become shareholders, you might need to provide them with quarterly management reports and get their vote on company decisions. This may be appropriate for investors, but usually, not something you want employees to have to get involved with. That’s why a lot of companies choose to only allow options to be exercised when an employee leaves or the company is sold.
The law and tax code of each country affects the type of scheme you can set up for your employees.
Most European countries and the UK have government-approved share schemes that come with certain tax benefits.
In the UK, there are two types of share option schemes that are best suited for startups and SMEs.
EMI scheme
This scheme is backed by HMRC and designed for UK-based PAYE employees who work for your company for at least 25 hours a week or 75% of their working hours. The scheme is great because it has tax advantages for your company and share options recipients.
Unapproved scheme
This scheme is for everyone the EMI scheme doesn’t cover (like non-UK based team members) and for companies that aren’t eligible for an EMI scheme.
The scheme is called ‘unapproved’ because it’s not backed by HMRC. All that means is that there aren’t tax advantages associated with this type of scheme.
Share option schemes have become popular because they have multiple benefits for companies and team members. They:
How you set your scheme up will depend on the country you’re in, but generally, you’ll:
Can I get back unallocated share options when I sell my company?
Yes. To give share options to your team, your company needs to create an option pool.
Shares in the option pool start out unallocated – that is, you haven’t promised them to anyone yet. As your company grows, you allocate options from the pool by granting share options to team members and advisors.
If/when you sell your company, you might have already allocated all the options in the option pool. But if there are any remaining, those are the unallocated options. If there are unallocated options, this means the founders created an option pool that was ultimately larger than needed, and therefore they unnecessarily diluted themselves.
“There will often be restrictions in the company’s Shareholders Agreements and Articles which say that share options can be allocated to employees, but not to the founders. That’s to avoid founders just giving themselves options whenever they feel like it.
But when it comes to selling the company, if there are unallocated options remaining in the options pool, that doesn’t seem fair because the option pool was created by diluting the founders’ shareholding.
To get back unallocated options, make sure there’s a clause in your Shareholders Agreements and Articles stating that on the sale of the company, unallocated options can go back to the founders” - Anthony Rose, Co-founder and CEO, SeedLegals
If you create the documents for your funding round and create your option pool on SeedLegals, you can easily add this clause to your documents.
When is the right time to set up a share option scheme?
The right time is different for different companies – it depends on your revenue, how many full-time employees you have at the moment, and your plans for hiring and fundraising over the next year.
These are three triggers which could mean it’s the right time for your company to set up an option scheme:
Can I give share options to influencers and customers?
Yes. But you need to take care when coming up with customer and influencer reward programmes that involve equity. This is because complex rules around taxation and, most importantly, securities laws come into play.
Read what you need to know in Giving share options to customers and social media influencers.
Can you have more than one share option scheme?
Yes. Usually, you’ll do this because you’ve allocated all the options from the option pool. Then you can create a new pool and start a new scheme. Or you might want to run another scheme with a different set of rules.
Thinking about giving share options? SeedLegals is a quick, easy and cost-efficient way to create and manage share option schemes.
