Giving your employees share (or stock) options is a way to incentivise them. It can serve to retain key employees and provide a part of their compensation that is linked to the company's performance. This, hopefully, aligns their interests with yours. It also means that your company holds onto the actual shares for a period of time after you’ve divvied out the options. That can be useful if staff come and go and you don’t want them to leave and continue holding shares in your business.
Here are basic terms that explain share options:
Shares
These are what founders and investors have; real shares that can be traded if and when there is a market for them. That might happen if the business goes public or is sold.
Share Options
These are a right, but not an obligation, to buy shares in a company at a certain date, or series of dates, in the future at a pre-determined price.
Grant of Share Options
Simply, that your employee is given the right to buy a certain number of shares at some point in the future, at a price that is defined now.
Grant Date
The date on which an employee is granted the share options.
Vest
When the options vest the employee has the right to exercise (or buy) the shares on that date.
Vesting Period
This is the period at the end of which they have the right to exercise (or buy) the shares. It might be months or years into the future.
Exercise
When the options vest your employee then has the right (but not the obligation) to buy the shares. They can hold onto the options if, for example, the actual share price on the vesting date is lower than the exercise price granted by the option.
Exercise Price – this is also known as the grant price or strike price, and is the price of the shares paid when your employee buys them. This price is set when the options are granted.
Share Price – this is the price that the shares are selling for (or being bought for) on the date the share options vest.
Expiration Date – the date after which the options expire and the right that's been given to buy shares is no longer available.
Initial Public Offering – the IPO is when the company goes public, which means its shares are now traded on an open market on, for example, the London Stock Exchange. Normally at an IPO, money is raised from new investors to enable the company to grow. This can also be the time when the founders of the business sell some of their shares to get some money to buy expensive cars, houses and other trophies. Share option holders may also be allowed to participate in an IPO, using their granted options to buy the company’s shares at their exercise price and then immediately selling some or all of them at, hopefully, the higher share price, and pocketing the difference.
Liquidity Event – this is when your company goes public and its shares can be bought and sold on an open market.
Here’s an employee example:
Tom has been granted 5,000 share options (i.e. an option to buy 5,000 shares) at an exercise price of £1.50 per share. This allows him to buy 5,000 shares in his company for a total of £7,500 at the end of the vesting period, which is in 2 years’ time, the vesting date.
The offer to buy the share options expires in 4 years after which the options will have no value. The right to buy the options will also automatically expire if Tom leaves the company before the vesting date.
When the vesting period ends, Tom can buy the 5,000 shares at the exercise price of £1.50 per share. At that time he will pay the company £7,500. However, simultaneously, he can either sell some or all of the shares at the current share price, which has risen to £5.00 per share. He'll make a profit of £3.50 per share on any shares he sells. He can also hold onto them, or decide on a combination of sale and hold.
There are, as you might expect, a lot of tax regulations around share options, and the rules frequently change. You can find out more at gov.uk
Comments