What are share options?
Share options are agreements between a company and another party entitling the latter to buy shares in the company under certain conditions. A price will be specified, as well as, in most cases, a time limit for purchasing or a specific event that will trigger the purchase. This is distinct from the conventional purchase of shares as options are an agreement to a future sale. Share purchase, on the other hand, is effective immediately and the buyer becomes a shareholder.
Advantages of share options over share purchases
There are a number of relevant advantages of offering share option agreements rather than direct share purchases. Some of these include:
- The ability to tie the options to company performance to align personal and collective goals
- Retention of shareholders’ existing stakes in the short-term
- Prior to exercise, options usually do not entitle the holder to dividends
- Granting options rarely results in taxation. When acquiring shares directly, however, purchasers often pay either market value for the shares at the time or pay a tax charge on this value
- As they relate to employees, share options can expire upon an employee leaving. Direct allocation of shares may require a buyback clause for exiting employees
How does the term ‘unapproved’ share option agreements apply?
One of the more flexible forms of share option agreements is the unapproved share option. As a subcategory of share options, it too involves a company granting a certain number of options to an individual. Due to changes to the statute in 2014, so-called ‘tax-advantaged schemes’ no longer require approval from HMRC. Intuitively, unapproved share options did not require HMRC approval prior to and post-2014. Unapproved options also need not comply with any statutory requirements or certain employment regulations. There are few limits that may be put on writing the aforementioned advantages, allowing for flexibility.
For instance, share option agreements granted to employees usually require the individual spend at least 75% of their working time with the company. Under an unapproved scheme, a company can issue share options to part-time employees, consultants, contractors, and so on.
By incorporating part-timers into the program, business goals can be aligned with employee performance. In addition to full-timers, part-timers will be able to participate in the program, aligning their performance with business goals
Advantages of unapproved share option agreements
Unapproved options have further benefits due to this flexibility. Some of these benefits include:
- The ability to incentivise key contractors and freelancers
- Offering a reward to all types of employees for contributions to the success of the business
- Flexible terms that fit your business, including the terms of exercising the option.
- A company may grant any number of shares it wishes.
- Even if the price of the option is below the market value, the employee can avoid paying tax.
- After an exercise of options, a company may receive tax relief upon meeting specific criteria.
Contracting and taxation of unapproved share options
Grant of options
Upon granting the shares there must be an option agreement. This contains all of the essential terms between the company and the optionee. This will include the option price. Note that since no tax is owed upon granting of an option, the parties are free to agree on any exercise price from the share’s nominal value add Infinitum.
In unapproved share option plans, the parties have significant flexibility. This allows the terms to fit the specific needs of the business, particularly as regards vesting conditions. Optionees must meet vesting conditions before exercising their options. These conditions usually relate either to time or performance.
Exercise of the option can only take place after a specified time period has passed. This is frequently used as an incentive to keep workers for longer. Performance requirements relate usually to the performance of the company, allocating share capital as if it were a bonus to the recipient. Commonly, firms will also vest options after an ‘exit event’. This will usually involve some change in management or control such as a buy-out.
Noteworthy is the advantage of ‘leaving provisions’ which often are drafted to ensure that an option becomes ineffective once the employee leaves the company. Buying direct shares would require a repurchase clause, which might complicate the process.
For further information
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