What are share options?

Why companies love share options

Share options are a way cash-strapped (or cash-savvy) companies can reward key people for their hard work and loyalty, and attract new talent.

Not all startups and SMEs can stretch to a super competitive salary, so offering equity as a means of compensation can sweeten the deal.

Another reason why they award options, is to improve retention. In the early days in small teams, everybody chips in. And if one person leaves, it can cause serious bottlenecks.

By setting up a share option scheme, companies can encourage team members to stick around for longer, because the longer they stay, the more options they’ll earn. And those options could be worth a significant sum one day.

Options are also an incentive that an inexperienced founder could use to tempt an experienced entrepreneur to come out of retirement and play a supporting role in their new venture.

Why employees love share options

In a world where salaries don’t always keep up with inflation or the cost of living and pension pots don’t look promising, having shares in a business could prove to be financially beneficial in the future.

Then there are the tax benefits. Depending on the type of share options, employees can delay paying taxes on the value of the shares until they sell them and even pay a reduced rate.

Skip to the tax implications of share options.

When can employees exercise their options?

First of all, even if a company grants an employee share options, they can decide whether they want to exercise them at all.

Exercise = convert options into shares to buy, keep or sell.

But as for when they can exercise their options, well that depends on a couple of things:

1. Is the scheme exit-only or exercisable?

2. Is there a vesting schedule?

An exit-only scheme means that employees have to wait until an exit event occurs, like a sale, merger or acquisition.

If it’s an exercisable scheme, employees don’t necessarily have to wait for an exit but they have to complete or pass key dates outlined in a vesting schedule before they can do anything.

A vesting schedule outlines when and how often options vest (earn their value) as well as when and under what conditions the employee can exercise them.

Note: a vesting schedule can be part of an exit-only scheme too.

If you're set to receive options, read your option agreement thoroughly to make sure you fully understand what you’re signing up for. How much you ultimately pay for your options depends on the exercise price set and tax.

How are options taxed?

Now for the boring but important bit.

Share options are subject to tax in the UK. The exact tax treatment depends on the type of option, the exercise price, and the time period over which the option is held.

Here’s a brief overview of the tax implications of each of the four schemes we've discussed:

1. EMI options

With EMI options, no income tax or National Insurance (NI) contributions are due when employees receive the initial grant.

Paying tax comes later when (or if) they decide to exercise their options, and even then, the rate of Capital Gains Tax (CGT) they’ll pay is lower*. That's because EMI options are usually eligible for Business Asset Disposal Relief.

*If the exercise price is below the actual market value (AMV) of the options at the time they were awarded. Read everything you need to know about EMI and tax.

EMI benefits companies too, as they can usually claim corporation tax relief on the full amount of an employee’s option gains.

2. CSOP options

CSOP options are subject to income tax and NICs when the option is exercised.

But CSOP options are eligible for tax relief, which is based on the difference between the exercise price and the market value of the shares at the time the option is granted.

3. SAYE options

SAYE options are not subject to income tax or NICs when the option is granted or when the savings are made. Those taxes apply when the option is exercised.

Like with CSOP options, the amount of tax due will depend on the difference between the exercise price and the market value of the shares at the time.

There may also be capital gains tax (CGT) implications when the shares are sold.

4. Unapproved options

Generally speaking, for employees, unapproved options are subject to income tax and national insurance contributions (NICs) when the option is exercised. For non-employees, it's a little more complicated. Learn more.

The first steps to set up an option scheme

If you’re thinking about setting up an employee share option scheme, here are the first steps you need to take:

1. Decide how much equity to give 

2. Decide which option scheme is right for you

These initial steps are arguably the hardest part, but once that’s out of the way, you can move on to designing, launching and managing your options scheme.

Use our free calculator to work out how many shares to set aside for your team.

How to manage option schemes

You’ve come to the right place. While you could ask an accountant or a lawyer to manage a share option scheme for you, there’s a far more cost-effective choice.

Vestd is the UK’s original share scheme and equity management platform. We’ve helped thousands of business owners not only set up option schemes but manage them effectively too.

Set up your EMI option scheme, CSOP or unapproved option scheme today.

Free resources

• Equity Fundamentals
• How vesting works (the employee guide)
• The Complete Guide to Company Share Schemes
• Conditional Equity Milestones
• Shared Ownership Calculator