All You Actually Need To Know About Share Options

All You Actually Need To Know About Share Options

Posted on: 23 Nov, 17

Running a business can sometimes feel like you’re rowing a boat alone. How can you help incentivise your hand-picked, super team to pick up the oars and get paddling? Just give them shares of course! Or is it that simple? Oury and Clark are back with some rowing lessons.

clark normal

So I got a letter from a client today

oury normal

Do you mean like a proper letter through the mail or do you mean an email?… What did it say?

clark normal

No a proper letter…it was a bit of a brain dump really…and then she started going on about dragon boats… a bit random really, but the gist was that she wanted to give some shares to some employees and some shares to a non-executive director, she did a bit of reading – and then (unsurprisingly) she got a bit lost…she asked herself: Do I want share options? Do they get taxed? Do I get taxed? Does it matter if the people I want to offer shares to are employed or not or whether they are based in the UK or abroad?

oury positive

good letter… good questions, I’m intrigued though about the dragon boat.

clark normal

Actually, I got the dragon boat reference in the end, it was an analogy for getting everyone to work as a team, paddle in unison, through clam and choppy waters… so not all that random.

oury positive

t’s a great analogy because as the owner of a company you do need every one committed and heading in the right direction and it’s the owner that then bangs out the rhythm on the drum.

Here’s all you actually need to know about share options…

a. It’s a nightmare to get them back, if you are able to at all

b. and that’s if you write into your company’s articles that you have a right to buy them back!

c. If the people who control the company decide to give shares away – it could be a taxable disposal on them – as they are giving away some of the value of the company.

d. People often don’t value shares half the time. So – make sure that if you are going to give them away they value them (and make sure you also think about what you want to happen if the person leaves the company or you have some sort of falling out).

e. Lots of VCs dislike minor shareholdings so think about what your future funding strategy might be if you are going to go to the market at some point in the future.

f. Appreciate the law around giving your employees shares. As far as HMRC see it – giving an employee shares is akin to paying them in cash… i.e. they pay full income tax on it. They must always pay market value when they get the shares or full income tax on difference. If you are small company starting up with a high valuation that could be a huge tax bill, for utterly illiquid and perhaps shares, which in reality might be valueless…(no offence you entrepreneurs).

g. That’s why some bright spark invented share options.. .an option to buy shares at a future point of time, at today’s price (assuming it’s an approved scheme… )

a. Share options aren’t actually shares

b. They are a promise to an employee that they can buy shares in the future

c. Generally, employees can’t afford to buy shares at market value, so having an option to buy them in the future at a specific price determined today is helpful to them.

d. When the company is sold, or is floated, a share option gives an employee a right to exercise their option to buy the shares at the time of the sale or float (i.e. effectively netting off the price to buy the share against the proceeds from the sale of the share).

There is really only one type of share option that’s tax efficient (known as an EMI option), despite there being more than 4 other types of option schemes:

a. If you want to incentives some or all of your employees and you aren’t a really big company (meaning with assets over £30m – so pretty big) there is only one choice when it comes to an HMRC APPROVED share scheme. See here for more detail.

b. A tax approved EMI scheme allows an employee to buy the shares at the current market value when the option is granted, rather than the price when you actually exercise the option to buy the shares. This generally occurs years later when the options are hopefully very valuable

c. Generally, employees can’t afford to buy shares at market value, so having an option to buy them in the future at a specific price determined today is helpful to them.

d. If you put in place an HMRC approved EMI scheme it is really tax efficient both for the employee and for the employer. See here for more details.

For more information on Enterprise Management Incentives,
check out our quick guide

a. Well there are generally two types of “not an employee”. Those that really are genuinely not employees, and those that are providing services and might be considered UK based employees. Let’s deal with the former (as we deal with the latter at 6 below).

b. Clearly not an employee.

c. Well you can give them share options if you wish. They are non-approved option and the individual doesn’t get any tax relief on them if they are not working a sufficient amount of time for the business (25 hours a week or 75% of their working time). This means it’s mostly bad news. When they exercise their option to buy the shares they will suffer income tax on the market value of the shares at the time – less what they paid for them (the exercise price). Which may be a lot – but they potentially would still make money. So it’s not all bad. Tax man is happy though.

To check employment status click here

a. If the individual is not in the UK – sadly all bets are off. This is where tax gets infinite in expense and complication. You just grant them unapproved options discussed at 4 above – and they will have to work out what the impacts are on them locally from a tax perspective.

a. If you want to give shares or share options to a Non-executive director … it’s difficult to do it tax efficiently

b. Non-execs are employees, basically. Plenty try and argue differently, but they are … they are performing director duties for the company, this can be unpaid and there are situations and arguments – but generally they are employees.

c. BUT, they generally don’t contribute significant enough amounts of time to the company (25 hours a week or 75% of their working time) to be eligible for EMI shares.. and can’t get the 10% tax rate called Entrepreneurs Relief unless they own at least 5% of the company … so they really get the worst of both worlds and therefore it you want to incentivise them through share options (or reward them for giving their time for free – sweating ) your only real option is point 4 above.

clark excitement

Wow, you’ve been busy Oury, my head is spinning at the minute just trying to take all of this in… but hang on – are you saying therefore there are NO good options for NON-executive directors. That seems crazy

oury positive

Well actually you’re right – there is a better solution – check these out…

These shares are valueless on day one – and have no right to dividends, or voting – but purely a right to the increase in the value of the company. They may sound perfect – BUT…

a. You need a highly accurate valuation on the date of grant – which you can never guarantee HMRC will agree with;

b. Each time you want to issue new growth shares you have to get another valuation;

c. They require fairly complex changes to the company’s Articles, and need to be clearly defined;

d. S 431 election should be made, within 14 days of acquisition, to pay income tax on the unrestricted market value of the shares, usually the nominal value (e.g. £1).
Any uplift in value will then be subject to capital gains tax at 10% or 20%, rather than income tax rates of 20%, 40%, 45%

e. Basically they are complicated – and expensive to set up. But they do exactly what you want to do. . Give an employee a piece of the future growth in value of the company without causing them endless tax issues or having to put up any money today.

clark excitement

I’m starting to get my head around this now, which is great, but what about our clients who want to grant share options to UK based employees when the UK company is just a subsidiary of a foreign company?

oury normal

Very good question Clark! It is common around the world that share options must always be granted in the PARENT company – and so even if you do grant shares in the overseas parent company, when the people getting these options – you must be aware that Foreign companies should still apply to HMRC to have the grant of share options in the overseas parent company recognised as one of the approved share option schemes.

clark positive

Thanks for clarifying that…and yes, I think it’s a great way to summarise a rather complex topic and as an employer if you get it right AND employees understand it, then they can be a great incentive to ensure everyone paddles strong and in the same direction.

For an overview of UK share option schemes check out our quick guide

Disclaimer

We are but two fictitious characters throwing out ideas and comment to stimulate debate and collect information. As professional service firms, we are open-minded people and think independent thought and debate are essential to help us understand as well as navigate complex problems. By joves – doing business across Europe (and the world) is set to become a whole lot more complex in light of recent seismic political events. As businesses – we provide information and hopefully some wisdom – and we see this blog and its caricatures merely as a much more fun, perhaps slightly controversial, way of stimulating debate and collecting ideas. We’re searching for some true pearls of wisdom, and as we find them, we’ll share them with you.

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