Share Options

What is a share option?

A share option is an agreement under which a person (called the “option holder”) has the right to purchase shares in a company at a future date.  Share options are usually granted by company, which enables the holder to invest in the company in exchange for new shares being allotted. However, it is also possible for a share option to be granted by an existing shareholder, enabling the holder to buy some or all of the existing shareholder’s shares directly.

The holder does not acquire shares immediately on the grant of the option, but have the right (but not the obligation) to purchase the shares at a later date, provided the criteria set out in the share option is met.

What types of companies grant share options?

Share options can be a useful tool for many types of company.

Share option schemes can be very popular with start-ups who want to attract staff with key skills. Offering a chance of share ownership at start-up stage can be hugely attractive to staff who can then benefit from growth in the value of those shares as a result of the company’s success at a later date. This arrangement can benefit both the employee and the company.

However, share options are also a useful to more established companies when it comes to attracting incentivising employees.

Share options are not exclusively for employees – whilst they are a great tool to motivate employees, a share option can be granted to anyone.

Does a company need a formal employee share scheme?

No. It is possible for a formal option scheme to be put in place, however it is not compulsory to do so.

There can be significant tax advantages to implementing what is called an “enterprise management incentives” scheme (commonly referred to as an “EMI scheme”). The key benefits to an EMI scheme are primarily that an employee can be granted an option to purchase the shares in the future, but at their current market value at the point the option is granted. All being well, the market value of those shares will be higher at the point the employee exercises the option, however the employee will not be penalised (for example under capital gains tax) for paying the lower fixed price for the shares.

In order to grant EMI options, a company must meet several criteria. They should also be satisfied that it is the right company share option scheme for them. There are alternative share option schemes which can be put in place, including a non-tax advantaged or “unapproved scheme”. Whilst these options schemes may not be as tax efficient, they may be more appropriate.

A company can also grant share options to certain employees without implementing a formal company share option plan. For example, a company may have one or two key people who they want to reward or incentivise. In those circumstances, it may be simpler to grant options to those individuals on standalone terms, without implementing a full employee share scheme.

What are trigger events for a share option?

Each share option will vary as to when it can be exercised by the option holder.  Typical trigger events include:

1. Lapse of time. For example, the option may be exercisable after 2 years from the date of the option agreement;
2. Performance. For example, if the option holder has hit certain targets set down in the option.
3. Exit event. For example, the option can only be exercised in connection with the sale of all of the shares in the company.

Some share options will have a combination of trigger events, and some will have staggered trigger events for different tranches of shares (often called a “vesting schedule”).

For example:

• Option holder will be entitled to exercise the option over all of the shares 2 years after the date of the option
• Option holder must meet at least 80% of their KPIs for a period of 2 years from the date of the option;
• Option holder has an option over up to 150 shares, and may exercise the option over 50 shares after 6 months from the date of the option, a further 50 on the 1st anniversary of the option, and the final 50 on the 2nd anniversary of the option.

The trigger events can be drafted in any number of ways.  They key is that they must be clearly drafted to ensure there is no dispute as to whether or not the trigger event or conditions have been met, or on the other hand whether the option has lapsed and is no longer in force.  This can be especially difficult when linking in performance targets, especially around generating fees or securing clients.  The conditions therefore need to be carefully thought out and properly drafted.

What does a share option include?

In addition to setting out the trigger events, the share option may include any number of the following:

• The number of shares included in the option, and whether the option holder may purchase only some of their entitlement (rather than all)
• Whether the option will lapse after a period of time
• How the option is to be exercised
• What price must be paid for the shares (if any) upon exercising the option (i.e. often called the “exercise price”). This might be expressed as a set price per share, or might be expressed as a formula which would be used to calculate the price at the point of exercise.

The option will also include any other conditions the parties agree between them.  If the option is being granted as part of an EMI scheme, then as set out above the option will need to meet various conditions and formalities.

What to think about when putting share options in place

Before granting any share options, a company should think carefully about:

1. Whether they want to put a formal EMI scheme (or other company share option scheme) in place, or whether this is likely to be a one-off grant of an option
2. What types of shares they are happy for the option holder to acquire – will they have the right to dividends? Will they have voting rights? Typically EMI options would need to be in respect of ordinary shares (rather than preference shares)
3. How many shares they are prepared to allot. Do you want to set aside an option pool?
4. What the trigger events for exercising the shares will be (see below). When will the options vest? It is common for start-ups in particular to have a vesting period to ensure that the shares do not all become available immediately
5. What permissions (if any) the board will need to obtain to grant the option – usually these will be found in the company’s articles of association or shareholder agreement
6. What happens if the option holders want to leave the company after acquiring the shares? It is possible to provide that these shares must be transferred back to the company (or other shareholders) but this might require making amendments to the company’s articles of association to achieve this.
7. Will the holders be entitled to sell shares to other people in the future, for example on the open market? Typically, for employee shares in particular, a company will want to control who the company shares can be sold on to (and in what circumstances)

Do share options have tax benefits?

Some share options do have tax benefits, however this very much depends on the type of share option being granted.  For example, share options granted to employees as part of an EMI scheme carry tax advantages provided they are properly structured and meet certain conditions.

What documents are required for a share option?

The documents needed to put a share option in place will vary depending on the type of share option being granted.  For example, if a company wants to issue a stand-alone share option to an individual, which does not carry any tax relief, it would simply need to obtain any necessary permissions within the company to grant the option, and grant the option itself on whatever terms it agrees with the holder.

However, a larger and more formal employee share schemes will require a set of share scheme rules to be implemented.

The company may also need to make amendments to its articles of association and/or create a new class of share to be granted under the option.

We would also strongly recommend that you speak with your accountant to consider the various tax implications of implementing employee share schemes, in order to ascertain which is the most tax efficient and suitable scheme for your company, and which is in your best interests.

If you need any advice on share options, please contact a member of our corporate and commercial law team in confidence here or on 02920 829 100 for a free initial call to see how they can help.