Share options explained for employees

Got share options or been offered share options by your employer? Or are you thinking of joining a company that offers options? This post is for you.

We did a quick web search and found that most online content about share options is written for company founders or administrators. Which isn’t much help if you’re on the receiving end of share options.

What are share options? Why not just give me shares? Or more money? And how much are these options worth anyway? We’ll cover all that and more about how share options work in this, the UK’s most useful blog post (probably) for employees about options. 💪

Watch video

In this video, SeedLegals CEO Anthony Rose explains share options vesting and exercising, how to work out the value of your options, the tax advantages of EMI options, and more.

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Can’t watch the video? Here’s the auto-generated transcript.

What are share options? Why do companies give share options to employees?

Share options give you the right to buy shares in the company in the future, for a fixed price usually far less than the market value.

When you have share options, you can convert them into shares (‘exercise’ them) in the future to own equity in the company.

Many employers give share options to staff to motivate you – when you hold share options, you have a bigger personal stake in helping the company succeed.

Why not give shares instead of options? Or more money?

Shares give you a percentage of ownership of a company. If a company issues you ordinary shares, you immediately own those shares. That comes with certain privileges such as voting rights, attendance at meetings, receiving shareholder reports and so on.

The company doesn’t yet know how you’re going to perform – so rewarding you in shares right now would be a massive gamble. Plus when you’re issued shares, you’re liable for Income Tax, and when you sell them, you’re liable for Capital Gains Tax. Big headache.

Enter share options as a much better way to reward staff with equity in the company. Share options give you the right to buy shares in the company in the future, for a fixed price. As an options holder, you don’t yet own the shares.

You’d prefer more money instead? Options are especially popular with startups which often can’t pay the higher salaries offered by bigger companies because they don’t have enough revenue. Options are a way to reward you without adding to the company’s expenses. Although it can be tricky to work out what your options might be worth in the future, you could end up better off financially with a lower salary plus share options than if you’d taken a job with a higher salary but no share options.

What is vesting of employee share options?

When you’re granted share options, they’re nearly always allocated in batches over time. This gradual allocation is called vesting. ‘To vest’ comes from old French and Latin meaning ‘to put into possession’. It’s the same root as the Spanish ‘vestir’ – to dress – your options are literally bestowed upon you, and become legally yours.

Why do share options vest? Because it’s far more sensible than giving you all of your options in one go, upfront. You don’t get paid your annual salary all in one go. Instead, you get paid in monthly instalments. It’s the same with options. This way, the company can check you’re performing at the appropriate level and earning your options over time incentivises you to stay at the company.

Your company sets the vesting schedule. Your vesting schedule could be the same as or different to that of your colleagues.

A common vesting schedule would be for the options to vest monthly, over three or four years. Or your company might set up options vesting in line with certain milestones, either personal targets or company achievements.

Here’s an example:

Let’s say your company grants you 1,000 share options, to vest monthly over four years.

If you leave after one year, you have 250 options vested.
The remaining 750 options remain unvested and they go back to the company.

If you leave after two years, you have 500 options vested.
The remaining 500 options remain unvested and they go back to the company.
And so on.

What is the cliff on employee share options?

As we’ve seen, vesting means that share options are usually allocated in batches over time. A vesting cliff is a way to build in a buffer before you receive any options.

It’s common to have a one year cliff before the share options you were granted start vesting. This allows the company to assess your performance, and to incentivise you to stay with the company.

We know ‘cliff’ sounds a bit weird – but it does look like a cliff on a graph (see below). For a while you get zero options and then boom, you reach the cliff and your options begin vesting.

What is share option exercising?

To turn your share options into shares, you need to exercise them. It sounds like dog walking but hey, we didn’t come up with this terminology. As well as ‘exercise’ meaning to jog, swim, go to the gym etc, it also means to put into active use. So when you exercise your share options, you’re putting them into active use as real shares in the company.

Your company sets rules on how and when you can exercise your options. This could be:

• only within a certain month or two of every year
• when all your options have vested
• after you leave (you must exercise EMI options within 90 days of leaving)
• when the company hits a specified milestone
• when the founders sell the company
• … or some other rule set by your company

To find out how to exercise your share options, check your Option Grant agreement or ask the person at your company who looks after the option scheme.

How much are employee share options worth?

This is a very common question: how do I calculate how much my share options are worth? Firstly, options themselves are worth nothing. Zip, zilch, zero. They’re only worth something when you exercise them and they become shares.

OK, so how do you work out how much your share options might be worth if you exercised them? It’s surprisingly simple: you need to multiply the number of options you hold by the price of one share.

value of your options = zero

what your options might be worth after exercise (that is, when they’re shares):
value of your shares = [number of shares you hold]  ✖️  [value of 1 share]
value of 1 share = [current valuation of company]  ➗ [total number of company shares]

Here’s a worked example:

Let’s say there are 1 million shares in your company.
At the last funding round in 2021, the company was valued at £8 million.
That was a few years ago and the company is doing well so let’s estimate the current valuation as £10 million.

Value of 1 share = £10 million / 1 million = £10
If you own 1,000 share options and exercise them (convert to shares), the shares would be worth: 1,000 x £10 = £10,000

What are EMI employee share options?

If you’re a PAYE employee at a startup, it’s likely that your company will grant you ‘EMI options’. EMI stands for Enterprise Management Incentive, a UK government scheme to encourage smaller companies to reward their teams with equity. The EMI scheme gives generous tax breaks – both for you and for the company.

When you’re granted EMI options, you won’t need to pay Income Tax or National Insurance contributions. And assuming you exercise your options at the pre-agreed price your company agreed with HMRC, then you also aren’t liable for these taxes when you exercise the options. 🎉

When you sell your shares (the shares you received when you exercised your options), any Capital Gains Tax you’re liable to pay is reduced from 20% to 10% if you’ve held those shares for over two years. Ten percent might not sound like much, but it might save you hundreds or even thousands of pounds.

What are Unapproved share options?

If you’ve been allocated Unapproved share options – which are particularly common for non-PAYE team members and staff who are tax resident outside the UK – then these options don’t have the tax breaks of EMI options.

The name ‘Unapproved’ doesn’t mean it’s not allowed or it’s somehow sneaky or under the radar. Unapproved just means the option scheme is your company’s own, rather than being set up under the rules of the government’s EMI scheme.

As an employee or director of the company, you’re liable to pay any tax when you’re granted Unapproved options – but you will be liable for Income Tax and National Insurance when you exercise your options, and for Capital Gains Tax when you sell your shares. Always check with a tax specialist before you exercise Unapproved options or sell your shares.

Are employee share options taxed as income?

If you’re a tax resident in the UK and granted share options in connection with your employment or directorship, there’s no Income Tax or National Insurance Contributions (NICs) to pay when you’re granted options.

You only become liable for Income Tax and NICs when you exercise your share options – unless you have EMI options.

For EMI options, the special tax treatment of your company’s EMI option scheme means that you won’t have to pay Income Tax or NICs when you convert your EMI options into shares.

What and when do I need to pay for employee share options?

When you’re granted share options, you don’t pay anything.

When you exercise your options to convert them into shares, that’s when you’ll need to pay the strike price. You might also need to pay tax.

When you decide to exercise your options, the company might ask you to sign an S143 form and an NIC election – these forms say that any tax liabilities that might arise from you exercising your options sit with you rather than the company. To find out more about this, head to our post: EMI and Unapproved options

If you have EMI options

The strike price will be at a generous discount on the market value of the shares at the time you were granted the options. The strike price could even be just a penny or a few pence per share.

Here’s an example:

Let’s say your company grants you 1,000 EMI share options with a strike price of 10p per option.

After three years, all your options have vested and you decide to exercise them.
You’ll need to pay the company £100 (1,000 x £0.10)

If today’s market value of 1 share in your company is £10 then your shares are worth £10,000 (1,000 x £10)
The ‘income’ you’ve gained is £9,900 (£10,000 – £100) 🤩

And because they are EMI options, you won’t pay any Income Tax or National Insurance 🎉

If you have Unapproved options

The strike price won’t be discounted (like it would be for EMI options). Check your Option Grant for the strike price.

Here’s an example:

Let’s say your company grants you 1,000 options with a strike price of £2 per option.

After three years, all your options have vested and you decide to exercise them.
You’ll need to pay the company £2,000 (1,000 x £2)

If today’s market value of 1 share in your company is £10 then your shares are worth £10,000 (1,000 x £10) 🤩
The ‘income’ you’ve gained is £8,000 (£10,000 – £2,000) 🤩

Because your options were Unapproved rather than EMI, you’re liable to pay Income Tax and National Insurance Contributions on the ‘income’ of £8,000 😕 (the amount of tax you’ll owe depends on your personal circumstances)

What happens if I never exercise my share options?

If you have EMI share options and you leave the company, you’ll need to exercise those options within 90 days of leaving, or you forfeit them and they go back to the company. (If you have EMI options that are ‘exit only’, then if you leave the company before the founders sell it then you forfeit the options anyway and they go back to the company.)

If you have Unapproved share options, there might be an expiry date on your options, for example, 10 years from the date you were granted the options. Check your Option Grant agreement for details. If you don’t exercise your options before the expiry date, they go back to the company.

If you’re granted share options but you don’t exercise them or they expire, then you won’t be liable to pay any tax.

Can I sell my employee share options?

You can’t sell or transfer share options to someone else – they’ve been allocated to you and unlike shares, you can’t sell or transfer them.

However, if you exercise your options, they become shares – and then you can sell them. You can sell them on the open market (if that’s possible) or you could ask the company to buy them back from you.

After I exercise options, how do I sell the shares?

Even when you legally own shares in the company, there might be restrictions on what you can do with them. Check your Option Grant agreement and, when you’re a shareholder, the Shareholder Agreement.

If you work for a private company

It’s common for employees at private companies (clue: the company name includes Limited or Ltd) to hold onto their shares until the founders sell the company or until the company goes public (makes its initial public offering, IPO).

• If you want to sell your shares but a company exit doesn’t appear likely any time soon, then you can ask the company to buy back your shares
• If the founders sell the company, the buyers might offer to buy all the shares, including yours
• If the company exits via an IPO, then you can put up your shares for sale in the IPO

If you work for a public company

If you’re working for a PLC, it’s possible to buy and sell your shares in the company on the open market. You can sell your shares via a broker, transfer them to someone else via a private sale, or ask the company to buy them back from you.

We recommend you consult a tax specialist before you sell your shares, to make sure you clearly understand the financial implications.

Should I hold onto my share options or exercise them? Should I sell my shares now or wait?

These are very common questions and the answer depends on your personal circumstances and how successful the company is.

To help you make your decision, here are some factors to consider:

• Is it possible to exercise your options right now?
  Check the rules of your option scheme.
• When do your share options expire?
  If it’s many years in the future, then you have longer to decide.
• Is it possible to sell your shares?
  This will depend on whether the company is private or public, and if it’s private, what your Shareholder Agreement says.
• How much are your shares worth right now?
  Or how much would your options be worth if you exercised them?
  See above, How much are my share options worth?
• How much might the company valuation go up in the years to come?
  If you work for the company, it can be more tricky to be objective about this.
  ↗️ If you think the valuation will go up, then your shares will be worth more in the future. You might decide to hang onto them as an investment.
  ↘️ If you think the valuation will go down, then your shares will be worth less in the future. You might decide to sell now while you think their value is higher.
  Just like any investment, the value of your shares could go up or down.
• How much do you need the money right now?
  If your shares are worth a few thousand pounds and you could really use that money now, then you could decide to sell the shares and pocket the cash. Or reinvest the money elsewhere.

We’ll say it again: we highly recommend you consult a tax specialist before you sell your shares, to make sure you clearly understand the financial implications.

Talk to an expert

Are you an employer thinking about setting up a share option scheme for your staff? Take a look at our resources about options and book a free call with one of our friendly experts.