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What You Need to Know about Share Options for Your Business

Sara-Jane Mok | August 9th, 2017

If you are new to running your own company, you would be familiar with the concept of shares in the company. But what are share “options”, and should you have them for your company?

What are share options?

Share options are essentially rights granted by a company to another person which enables that person to buy shares in the company at some future time. Typically, the price for buying the shares is fixed at the outset when the options are granted, which means that the person will be able to buy shares at this fixed price even if the shares increase in value over time (and effectively pocket the difference as a financial windfall).

Often share options are granted by companies as an alternative form of remunerating employees. To give a practical example, Sabrina and Owen are the owners of a start-up company. Their employee Cynthia is a rising star, and they want a way to recognise her hard work while ensuring that she is committed to working with them for the long run.

What you need to know about share options for your business

The only problem for Sabrina and Owen is that their business is still in the research and development (R&D) phase, and they don’t have sufficient cash flow to give Cynthia a pay rise in the near future. As Cynthia is still young and has plenty more to learn, Sabrina and Owen want to wait before offering Cynthia an ownership stake in the business, by giving her shares in the company.

In Sabrina and Owen’s case, share options might offer the best of both worlds, by ensuring Cynthia can be financially rewarded even without a pay rise, whilst also ensuring that Cynthia continues to be incentivised to perform strongly over the longer term.

At this point, you might ask whether Sabrina and Owen should consider an employee share scheme. Well, not quite, although a share options scheme is not that different a concept. As the names suggest, the main difference is that under a share options scheme employees are granted a right (i.e. option) to buy shares in the company in future.

At the same time, share options are not just for employees and they can also be offered to existing shareholders and third party investors.

Handpicked related article: Employee Shares Schemes – On the Money

What are the benefits?

There can be a number of benefits for both companies and option holders:

  • Companies are not required to issue shares straight away.
  • The parties can agree in advance on:
    • the future purchase price of the shares
    • the nature of the shares, including the type of rights attached to the shares
    • the timing and other requirements for purchasing shares by “exercising” options (for example, the ability to exercise options could be contingent on agreed KPIs being met).
  • Relieving pressure on cash flow and offering salary packaging alternatives for employees.
  • Providing an incentive for the employee to improve their performance as they will have a vested interest in the growth and performance of the company in order to increase their own wealth in future.
  • Improving employee engagement, retention and satisfaction.
  • Allowing investors the opportunity to observe how shares behave before committing to buying the shares, and if the investor decides not to exercise the option, only the amount paid for the share options are lost.

What you need to know about share options for your business

What are the disadvantages?

This arrangement also poses certain risks to companies and option holders. The biggest risk is that you cannot predict the future and how well or poorly shares in the company will perform over time. Disadvantages include:

  • The risk that the value of shares (and therefore share options) will fall through fluctuating market conditions or adverse decisions made by the company.
  • Potential problems or disputes may arise if the terms of a share option agreement are not drafted clearly in relation to the requirements for being able to exercise the share options.
  • Changes to existing shareholdings (i.e. dilution) will occur once share options are exercised.
  • Costs and complexity associated with establishment and administration of employee share option scheme.
  • Investor trading in options is complex and risky and should be done in consultation with a licenced broker.

Some other considerations

There are also other important issues you should consider before deciding to grant share options:

  • Whether the option holder is someone you want having equity (or increased equity) in the company.
  • How to issue share options in accordance with the company constitution and company/corporations laws to ensure that the share options are valid.
  • Capital gains tax and other potential tax implications.
  • Special tax rules that apply to employee share option scheme, including the concessional tax treatment for eligible start-up companies.

Putting a share options arrangement in place can be a complex process. If you are considering offering share options to investors, shareholders or employees, mdp can provide you with strategic and legal advice to achieve the right commercial outcomes for your business.

Sara-Jane Mok

Sara-Jane Mok

Lawyer, BSc LLB GradDipTax at mdp
Sara-Jane joined mdp as a lawyer in 2016 and started working in the firm’s property, commercial and intellectual property practices. Prior to joining mdp, Sara-Jane worked in Research & Development Tax at one of the ‘Big Four’ professional services firms assisting companies with preparing their Research & Development Tax Incentive claims. Her experience encompasses a range of industries, including financial services, agricultural, life sciences, engineering, manufacturing, software and start-ups.
Sara-Jane Mok

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