Share option schemes are popular amongst UK businesses looking to attract, motivate and retain employees, giving them a stake in future growth. Share option schemes need to be structured carefully, and the right approach will depend on the company’s objectives, its share structure and relevant tax considerations. A well-drafted scheme can provide flexibility and protection for the company, while giving employees a clear understanding of how and when they may benefit from it.
What is a share option scheme?
A share option scheme gives selected employees the right to buy shares in a company at a fixed price in the future. This fixed price is usually called the “exercise price”.
Options are often granted under a set of scheme rules, supported by individual option agreements for each participant. Typically, the employee can only exercise the options once certain conditions have been met. These might include conditions such as remaining employed for a specified period, achieving performance targets, or exercising the options shortly before a sale of the company.
If the company increases in value between the date the option is granted and the date it is exercised, the employee may benefit financially by buying shares at a lower price than their market value at the time.
A share option arrangement usually involves two key documents:
- A share option plan (or scheme rules): setting out the overall framework of the scheme, including who can participate, how options are granted, when they vest, and what happens if an employee leaves or the company is sold.
- A share option agreement: recording the specific terms applying to an individual employee, such as the number of options granted, the exercise price and any specific performance conditions.
Benefits of implementing a share option scheme
For many businesses, share option schemes offer significant commercial advantages.
Recruitment and retention: a well-structured scheme can help attract employees and encourage them to remain with the business for the long term. This can be particularly valuable for start-ups and growth companies competing with larger organisations that may be able to offer higher salaries. Vesting periods can also help incentivise employees to stay.
Aligning interests: share options can help align employees’ interests with those of shareholders. Employees who may benefit from an increase in the company’s value are often motivated to contribute to its growth and success.
Cash flow advantages: share option schemes can provide a cost-effective alternative to immediate cash bonuses or salary increases for employees. This can be useful for businesses seeking to preserve working capital while still rewarding key personnel.
Flexibility: there are various types of share option arrangements available in the UK, including Enterprise Management Incentive (EMI) option schemes which offer favourable tax treatment if the relevant statutory requirements are met.
Key provisions in a share option plan
Each option scheme will differ depending on the company’s objectives. However, several provisions are commonly included.
Vesting conditions: these determine when an employee becomes entitled to exercise their options. Vesting may depend on factors such as length of service, performance targets or a specific event, such as a sale of the company.
Exercise price and exercise window: the plan will usually specify the price payable for the shares and the period during which the options can be exercised.
Leaver provisions: the plan may govern what happens in the event an employee leaves the business. Many schemes distinguish between “good leavers” (for example, retirement or redundancy) and “bad leavers” (such as resignation or dismissal for misconduct). The treatment of the options often differs significantly depending on the circumstances of the employees departure. For more information on leaver provisions, please see our recent article here.
Change of control provisions: these deal with events such as a merger, acquisition or sale of the company. In some cases, options may vest early or become exercisable immediately before such a transaction completes.
Restrictions on transfer: share options are usually personal to the employee and usually cannot, therefore, be transferred or sold to another person.
Tax provisions: tax treatment is one of the most important considerations when implementing a share option scheme. Each type of share option scheme requires specific tax covenant wording to ensure compliance with HMRC requirements.
A share option scheme can be an effective tool for rewarding employees, encouraging long-term commitment, and supporting business growth.
Such arrangements involve a range of legal, tax and commercial considerations. Careful drafting of both the share option plan and individual option agreements is essential to ensure the scheme operates as intended, and protects the interests of all parties involved.
Whether you are considering introducing a new share option scheme or reviewing an existing arrangement, obtaining specialist advice at an early stage can help ensure the scheme is structured in a commercially effective and legally compliant manner.
How to get in contact
To find out more or if you require assistance with these matters, speak with our Corporate Team on +44 (0)204 600 9907 or email info@culbertellis.com.
Accurate at the time of writing. This information is provided for general information purposes only and should not be relied upon as legal advice.
