Shares vs options: what’s the difference?
The important difference is that if someone owns shares, they are a shareholder immediately. With options, they have own...
Share options are typically used to help you attract and retain the best employees, consultants and advisors by giving them the right to buy shares in the company in the future at a specified price. This price is usually a close-to-zero price, for example £0.001 per share, or for EMI options, at a price per share agreed with HMRC to give the maximum tax benefit.
Sometimes, a company may want to give options to people who aren’t employees or advisors. The use cases we see most often are companies that want to give share options to customers to thank them for their loyalty, or to influencers as a reward for helping the company get more customers. If that’s you, how should you go about this?
You can give share options to customers and influencers, but you need to take care when coming up with customer and influencer reward programmes that involve equity. This is because complex rules around taxation and, most importantly, securities laws come into play. This is why it’s normally large listed companies who reward customers with equity (like Domino’s with its Piece of the Pie Rewards programme and T-Mobile with its Stock Up campaign).
In the UK there are strict rules stopping companies or individuals that are not authorised by the Financial Conduct Authority from making “financial promotions”, which will impact how you communicate your equity reward programme to your customers or influencers.
If you’ve checked that you have all the necessary authorisations and safeguards in place, read on to learn how you can give share options to your customers or influencers.
Good news: you don’t need to set up an option scheme to give options to customers or influencers.
When you set up an option scheme on SeedLegals, the scheme rules specify who is eligible to receive options under the scheme. Our option schemes have been specifically designed for rewarding employees, advisors and team members who normally get share options that vest over a period of time, to reward the person for their work done over that time. Giving share options to customers in return for their buying your product is something different, which is why an employee share option scheme wouldn’t be appropriate for that.
Option scheme rules are specifically tailored to employees, consultants and advisors – the wording just won’t make sense for non-team members. For example, the scheme includes a Leavers section which explains what happens to the options when an employee leaves the company.
So, instead of creating an option scheme, you’ll simply do a standalone option grant. A well-drafted option grant will normally include at least the following details:
Let’s look at each of these in more detail below.
The option grant should specify what class of shares the customer or influencer will get when they exercise the option. You may want to create a dedicated share class with limited economical and political rights.
For example, if your customer or influencer eventually gets non-voting shares (on SeedLegals our preferred naming for that share class is B Ordinary non-voting shares), it will save you having to chase up dozens of minor shareholders every time a shareholder vote is needed, saving you a lot of admin overhead.
The option grant should specify how many share options the customer or influencer will get. Companies typically create a 10% share option pool, which covers giving share options to employees and advisors. So if you plan to additionally give share options to customers or influencers, those could either come from that same option pool, or you might consider making a larger option pool to accommodate both needs.
Either way, assuming you want to allocate, say, 5% total in share options for customers, if you plan to give options to 1000 customers that would equate to 0.005% equity each. That’s not a hugely enticing amount, so our suggestion is to never promise a percent equity to customers (which also adds confusion at the percent changes as you add more investment later) and instead promise a fixed number of share options. For example, if you’ve done a share split and have 1,000,000 shares, then you might offer 50 share options to each customer. That sounds interesting!
Want to learn more about giving advisors equity? Read our article on how much equity to give advisors.
You could – but you don’t have to – charge the customer or influencer a price (or require that they place an order, for example) when you grant them the share options. The important part is that they pay for the shares when they exercise their share options. The customer/influencer will have to pay the exercise price multiplied by the number of options granted.
The exercise price could either be a nominal (close to zero) amount or the current market value of the shares, e.g. the price per share in your latest funding round. Remember that there may be different tax consequences to the company and/or the customer/influencer depending on what the exercise price is so you should speak with your accountant before you decide what the exercise price will be.
You should specify when and how the customer or influencer can exercise their options – in other words, when they will actually receive the shares. For example, you might want to say that the customer/influencer can only exercise the option on a sale or exit of the company, or on some other liquidity event determined by the company.
It’s useful to require the customer/influencer to give the company a written notice, called an “exercise notice”, when they want to exercise their options. This will give both the company and the customer/influencer certainty about whether the customer/influencer exercised the options before they lapsed. When the customer/influencer gives you the exercise notice, it’s also a good time to tell them that they need to transfer money to the company’s bank account in exchange for the shares.
If you plan to give options to hundreds or thousands of customers or influencers, you’ll want to only allow them to exercise their options at certain specific times – read on for more on this.
If you only allow a customer or influencer to exercise the options on a sale or exit of the company or some other liquidity event, you probably won’t need a vesting schedule. On the other hand, if you want to allow the customer/influencer to exercise their option before then, you should decide how those options will vest – in other words, how they earn those options.
There are a couple of ways to structure a vesting schedule when you give options to a customer or influencer:
You might also want to set a time limit within which the customer/influencer has to exercise their options before they lapse, so you’re not on the hook if the customer/influencer tries to exercise the options years down the line.
If you’ve done a funding round, chances are that any prospective shareholders first need to sign the company’s shareholders agreement. If this is the case, and if you want your customers/influencers to be bound by (and privy to) your shareholders’ agreement, it’s important that the option grant includes a condition that the customer/influencer can’t exercise the option unless they sign a so-called deed of adherence before they get the shares.
If there are any other documents that you need the customer/influencer to sign (e.g. for taxation or compliance reasons) you should mention those in the option grant.
The use cases we’ve seen are companies that want to give options to hundreds or even thousands of customers or influencers.
When that’s the case, you’ll need to carefully think about when they’re allowed to exercise their options: on demand, or only on an exit or some other liquidity event determined by the company.
There may be business models and marketing strategies where it makes sense to allow customers/influencers to exercise options before an exit but in most cases, if you’re giving options to lots of customers or influencers, you’ll probably want a really simplified structure:
Now that you know what you should include in the option grant, you can take this to a lawyer who can help you craft your terms of service and the option grant in a way that’s both compliant with the relevant financial regulations and aligned with your marketing strategy.