Share options explained: the essential guide for UK startups
Understand what share options are, how to set up a scheme and how tax works on share options as we unpack all the import...
At SeedLegals our option schemes allows you to design your scheme to suit your company.
There are two main types of option scheme:
The above are examples of vesting – essentially they are conditions you put on the equity you give out to employees. You obviously don’t want to give someone a slice of your company, only for them to leave the next day. But as a founder, you’ll need to decide what type of scheme is right for your company. Let’s look at the pros and cons:
Milestone based vesting aligns your team with achievements of wider company goals. When done correctly, this type of option scheme can work well, especially for people in your team (for example, an adviser) whose main objective is to achieve, for example, closing your next funding round.
However, as soon as we look to the longer term, milestone based option schemes might not be as appropriate. If you look at your objectives three years ago, the chances are that they’re very different to what they are now. So if the company’s goals change, that can unfairly affect the opportunities for your employees to earn share options.
Also, milestones can often be ambiguous, particularly for people in roles that don’t have metrics which are easily defined – milestones might work well for sales and marketing, but what about for roles in operations, HR and product?
While there can sometimes be a place for milestone vesting – and of course you should track objectives for all employees – but for a company-wide share option scheme, we prefer the alternative: time based vesting.
At SeedLegals our strong preference for share options schemes is time based vesting – our preference is backed up with all the data we have from over 1,000 share option schemes we’ve helped companies set up. Firstly, there are a few bits of jargon to explain:
The time required for an option holder to earn all of their options given in a grant.
The minimum time required for an option holder to start vesting any of their options.
A cliff ensures that an option holder only gets rewarded if they have stuck with the company for a decent amount of time. If they have only been working with you for a few months, they probably haven’t contributed enough value to have earned the right to any equity in the business.
How often the option holder earns shares in their schedule – this could be monthly, quarterly or annually.
If you have a frequency of longer than monthly, this can motivate people to stick around until the next portion of options vest – but it could lead to employees leaving the business at a similar time, especially if you choose annual vesting.
Our data shows us that the most common choice for share option schemes is 4 year vesting with a 1 year cliff and monthly vesting frequency. After the first year, 25% of the holder’s options will have vested and the remaining amount will vest each month, for the next 36 months.
Time based vesting used to be less popular because you’d have to keep track of exactly how long people have been with you, whether they’ve passed their cliff and more. Now, thanks to SeedLegals, you can track this easily on one dashboard.
As time based vesting most closely aligns employees with founders and is generally seen as the fairest way to allocate options, the vast majority of companies who set up their option scheme on SeedLegals choose time based vesting.
Still not sure what type of share option scheme is right for your company? Book a call with our experts to talk about what’s possible.
Previously setting up an option scheme was complex, time-consuming and expensive. At SeedLegals, we’ve made it dramatically easier. And as with all SeedLegals services, we’re on hand to help every step of the way.