Definition: Share option is a benefit in the form of an option given by a company to an employee to buy a share in the company at a discount or at a stated fixed price.
Stock Option Plans permit employees to share in the company’s success without requiring a startup business to spend precious cash. In fact, Stock Option plans can contribute capital to a company as employees pay the exercise price for their options.
Here’s a few basics to get you orientated on share options. If you need detailed advice, you’d need to contact an expert.
ESOP
Firstly, you will need an ESOP (Employee Stock Option Plan) written up and approved by your board. You’ll normally need a good lawyer to draft this.
EMI scheme
You’ll probably want the ESOP to be under an EMI scheme (Enterprise Management Incentive). This is good for UK early-stage companies because there is no tax burden on recipients of stock option grants when they exercise their options. The only tax burden is on realisation of the gain (at exit) – capital gains tax. Note that EMI scheme options can only be granted to full-time employees and the earliest possible granting date is the first date of employment. There’s a maximum value that can be granted to any individual and there are eligibility criteria for companies to meet.
Valuation
Before you grant any options, you’ll need to get a valuation that you use for tax purposes from HMRC. Use a specialist lawyer or your accountant to make this application. Keeping the valuation low maximises gains for employees and therefore extends the impact of your stock option pool. A valuation once agreed usually lasts 60 days before it expires.
Documents
For each person you grant options to, you’ll need to issue them with copy of the ESOP and an option granting agreement (OGA). The OGA contains the vesting schedule. A typical vesting schedule for a UK venture backed startup would be over 4 years. After the end of year one, 25% of the grant vests (the first tranche), the rest would vest in equal amounts (6.25%) every quarter (the remaining tranches). Alternatively, you could vest over 3 years. You could also vest the final tranches monthly instead of quarterly.
Registration of Grants
The option grants need to be registered with HMRC within 92 days of being granted. Failure to do so would mean the employee not receiving the tax advantage. This must be done through the ERS Online Service. With the above be sure to keep detailed records in your data room of who has been granted options and when, together with proper files. If you don’t you’ll regret it down the line. It’s important to do this right first time out.
Further reading:
- HMRC guide to EMI schemes
- Guidance on EMI option schemes from Postlethwaites, an experienced team of solicitors who specialise in option schemes
A more detailed guide from Taylor Wessing, lawyers with good experience in the startup space