Share Options: How they work and what they're used for

A new job can bring many benefits but what makes you decide to leave the security of a well-paid job, or a comfortable 9 to 5 position, to join a growing company?

What are Share Options?

Share (or Stock) Options are the "right" of an employee to buy shares into the company for whom they work. They aim to achieve two objectives:

  1. Help the company grow by incentivising the employees to increase its value and;
  2. Give the opportunity to the employees to benefit from the value they have created.

Who gets them and who does not

All "qualifying" employees get options because they are expected to contribute - each one in their own way - to the growth of Popsa. According to HM Revenue & Customs, to qualify an employee must spend at least 25 hours per week or, at least 75% of their working time, being employed by Popsa.

The founders don't get any options. This means that all options are made available to the existing and new employees, as long as they qualify.

Many startups only grant share options to their most senior employees, but we have decided to open our scheme at Popsa to all employees, no matter what their seniority is.

This means that everyone who is building Popsa gets to share in our success.

How many options will I get?

The number of options received is usually linked to several considerations, the main one being their experience.

Usually there is a link between salary and options as they both reflect the same factors, i.e. talent, knowledge, work ethic and market competition.

Are all shares the same?

In Popsa, employee options convert into shares that have the same rights as the founders, this means that - unlike some other startups - when the company is sold us, the initial investors (who have bought their shares at a valuation of several million pounds) and the option holders will benefit from an 'exit' on the same basis.

Later stage investors tend to have shares with some additional rights (because of the large sums of money invested) but founders and employees will be in the same boat.

What percentage of the company will be owned by the employees?

Early stage startups usually set aside 7-10% (in the UK) and up to 20% (in Silicon Valley) of the original share capital for their employee options pool.

In the UK I have seen option pools as small as 5%.

Because of our decision to allow everyone in the company to own it, we have followed the Silicon Valley model for Popsa.

It is important to note that when we raise money from outside investors there’ll be a dilution for all shareholders. This is an incentive for all of us to make sure that the company grows a quickly as possible, reducing the need to raise additional capital from investors.

Google Share Certificate

Must employees pay for their options?

Yes, options have to be given a value, which is assessed on the day they are promised ("granted") to the employee based on the company's valuation amongst other things.

This crystallises the purchase price...

"But I have just started a new job! How am I going to pay for my options?!"

Some good news here: employees don't have to pay for them up front.

When you are granted options through an Option Agreement, you acquire the right of buying the shares but you only need to acquire and pay for them when there is a clear opportunity to subsequently sell the same shares, i.e. when a public listing or a sale of the company is imminent.

By that time, the value of the shares will (hopefully!) be worth much more than what they were worth when you were granted the option to buy them.

So if you have the option to buy shares at £1 and the company is sold for £100 per share, you will pay the £1 and receive the £100 at the same time, which means that you'll end up with £99 profit per share.

N.B. It is possible to convert your share options into shares before a sale, but you would need to pay for them directly rather than being able to cancel the payment out with the proceeds of a sale.

Do I have to pay any taxes?

Under Popsa's EMI scheme no income tax or national insurance is payable when options are granted (i.e. when they are offered to the employees). And again, no income tax or national insurance is due when the shares are exercised (i.e. the day they are purchased), as long as they were granted at market value. This is a requirement by HMRC designed to prevent people avoiding tax via the purchase of shares.

When the shares are sold, the employees who are still employed by the company will be liable for a reduced rate of capital gains tax (CGT). The entrepreneur’s relief rate is only 10%. Employees can also use their annual CGT exemption, so it is possible to pay less than 10% tax.

What happens if an employee leaves before the company is sold?

When an employee leaves they can exercise their options but only if they are "vested". They would buy them at the value agreed when the options were granted.

The payment due will be quite low for the employees who started to work with Popsa at the beginning of its life but could be higher for the ones that will have started at a later stage.

Because employees will not be able to sell their shares until the whole company is sold (or in case of some other events) Popsa will allow them to exercise them up to ten years from the day they were granted; this way a departing employee will not have to buy and hold shares while they are not able to sell them.

Did you say "vested"?

Obviously, it is not fair on the people who contribute to the success of the company if a person working for just a month or two takes their shares and leaves.

This means that employees must remain with Popsa for a pre-defined period before they will have acquired the right to purchase their options.

This period is called the vesting time, for which there is a schedule that is more or less the same in most startups.

Popsa's vesting schedule is a standard four years, which means that it will take an employee four years to fully vest their shares. After that time, the shares are theirs to buy.
The first 25% of the shares are vested after one year (this is called a "cliff").

After the cliff is passed employees will vest the remaining 75%, one month at the time (just over 2% a month).

 But what if the company is sold before vesting is complete?

Some good news here: if Popsa happened to be sold before an employee's shares were fully vested, they would automatically fully vest at that point.

This is called 'accelerated vesting'.

So, are share options a good idea?

Definitely!

And especially if the company is in its infancy and has a generous scheme.

Here at Popsa all of your colleagues will be contributing to each other's reward.

Will my options be worth a lot?

That's the plan!

Steve Jobs Apple Share Certificate