What – Broadly, a share option comprises a binding contractual right for a person to acquire shares in a company at a pre-agreed price. There are two kinds of option scheme: approved (tax favoured) schemes and unapproved (not tax favoured) schemes. Of the approved variety, Enterprise Management Incentives (EMI) schemes are the most common. They can be an invaluable strategy to start-ups looking to attract experienced staff. They are also useful to businesses at other growth phases looking to lock in value associated with key employees.
Who – Unsurprisingly unapproved options sacrifice tax advantages for flexibility and they can be granted to anyone (including consultants to the company). However, to be eligible under an EMI scheme there are strict requirements in relation to who can receive options. To be eligible, an employee must work for the company in which the shares are being granted for at least 25 hours per week or, if less, 75% of the total time he spends working.
Why – Share options provide an ideal strategy to motivate employees and enhance their value to the business. They are mutually advantages as they offer participation in the business they are helping grow (often dependent on such growth). As share options are exercisable at a future date and require the employee holding the option to remain in employment at the time they are exercised, they also assist with staff retention, thus reducing employment costs. In short, they can assist in recruiting, retaining and incentivising employees whilst enhancing performance, aligning the interests of management and staff and providing for exit planning.
How – An option can be granted to an individual employee under a single grant. Alternatively, a set of scheme rules can be adopted under which multiple grants can be made to numerous employees now and at a future date. Consideration must be given to how much share capital will be made available under the option. A long term view is necessary as future investors may be distracted by a large percentage of share capital being under option. A defined number of shares is generally preferable. The exercise price or “strike price” (the value at which the employee can acquire shares under his option) can be set at any value but tax advice should be obtained at the time of the grant in relation to valuation.
When – Options can be exercised in the future as a result of a myriad of conditions. The most typical triggers are the elapse of a pre-determined period of time (vesting period), an exit (sale or listing of the company) or following the satisfaction of specified performance criteria. The guiding principle here is that the option must never be less than a contractual right to acquire shares. Performance targets must therefore be clear and objectively achievable. Typical metrics include turnover or profit targets or reaching a specified stage in a project. Share options can also be linked to the individual performance of the option holder.