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Option Schemes 6 min read

Shares… Growth Shares… EMI Options… Unapproved Options… Which is right for your team?

Published:  Mar 20, 2024
Anthony Rose
Anthony Rose

Shares… Growth Shares… EMI Options… Unapproved Options… it all sounds so complicated.

But actually each is designed for a particular job, and once you know the basics, picking the right one is quite easy, as we explain here. In just 10 minutes you’ll know exactly which to choose for your team. And then you’re all set to issue those shares or options on SeedLegals.

A new person joining your company – a new co-founder, employee or advisor doing work for you – you want to give them equity. But should you give them shares, growth shares, EMI options or unapproved options?

It all sounds really complicated, but actually there are each a solution to a particular problem. And with a little knowledge, it turns out the choice generally to be quite simple.

In the next few minutes, we’re going to go through the choices and show you how to select the perfect way to give equity to a team member or advisor.

Let’s start with a new joining co-founder

Let’s assume your company recently incorporated and now you’ve got a late joining co-founder. Should you give them shares, or share options? Here your choice is generally shares. You’re going to give your new co-founder shares, they’re going to get, say, 20% equity.

Why give them shares instead of share options? The reason for giving somebody who’s getting a lot of equity, particularly a founder, shares as opposed to options, is because as the company raises investment and issues new shares, the founders get diluted. As a founder you want to have as much voting power as possible. If you give a new joining co-founder share options, they won’t have any voting rights until they exercise their options later. And so you’ll have fewer votes than had they gotten shares like you as a founder. By giving them shares and the founders then voting together, that gives the founders more voting power compared to the investors. And of course you should always give shares with vesting, typically over 3 or 4 years.

So that’s giving shares to new joining co-founders when the shares still have no value.

But wait, what if the shares have a value?

If the shares have a value and you give shares to somebody, that person receiving the shares has a tax liability. If the person’s an employee of the company, it becomes an employment-related security. Not only do they have an income tax liability, but the company has a tax liability as well. They need to pay the tax first and national insurance. Giving shares for free to somebody when the shares have a value is a bad thing to do. So if your company has closed a funding round already and obviously has a valuation defined, or where there’s a term sheet that’s been sent to investors, or you’re close to completing a funding round, or if the company has been trading for a while and has got significant revenue and has a value because of that, then giving shares to somebody is generally not a good idea, particularly if they’re an employee.

So what are your choices then? Well, your choices are growth shares or share options.

Growth Shares

What is a growth share? Growth shares are just like an ordinary share, but with what’s called a hurdle. A hurdle means that when the person sells their shares later, they don’t get back the full sale price of the share. they only get back the sale price minus the hurdle. So let’s say your last company valuation was, say, £5M. You’ve closed a funding round and that £5M valuation corresponds to a price per share of £1 a share. So I now have a late joining co-founder or an employee I want to give lots of equity to, and I’m going to give them growth shares. And I’m going to set the hurdle value to the same valuation as my last round a pound a share, £1 per share. If the person was to sell their shares tomorrow, the company gets back the first pound, the hurdle. But that’s the total price per share right now, there’s nothing above that. So the shares are worthless today. They only have a value if the company valuation increases in future. And because they’re worthless today, there’s no tax liability today. So your solution when giving equity large amounts, particularly to a late joining co-founder is if the shares already have value, growth shares are the answer. The idea is to get a share valuation to set the hurdle a little higher than your last share price so that the shares have no taxable value today. The person can have voting shares if you want them to have voting shares or non-voting if you don’t. And then later on when they sell their shares, they will get the increase in value above the hurdle. So if the share price doesn’t go up, they get nothing.

By the way, there’s one other use for growth shares, which is sometimes if companies have given away or sold too much equity in early stage funding rounds, the founders are diluted too much. The founders would like to give themselves more shares. And if the investors agree, they might think about giving themselves share options, but maybe they too late, they already have enough equity, or the companies used up all the EMI options.

EMI options

If it’s an employee and your company qualifies for EMI options and the employee qualifies, the answer is EMI options. Easy.

But what if it’s not an employee? What if they’re not in the UK? What if they are only employed part-time and don’t meet the requirements for an EMI share? Well, then the answer is unapproved options.

Unapproved options

Unapproved options don’t mean they’re illegal; it means you just haven’t approved a valuation with HMRC. And so they’re super easy to set up. You promise somebody options. You can set the exercise price later on when the shares or the options are vested, they will pay the exercise price to exercise their option, and then they can go and sell the resulting shares. When they exercise the option, they’re going to pay tax, but if the person is smart, they will only exercise their options at the point they’re going to sell the shares, often on a sale of the company. So they’re going to pay tax essentially on the value of the shares that they make. So the question is, when you are giving unapproved options to somebody, what exercise price should you pick?

Let’s say you have an advisor, a board advisor, coming on board for a year, and you decide to give them some share options. They don’t qualify for EMI options. So you’re going to give them unapproved options. So how are you going to go about doing it? Well, thanks to SeedLegals, it’s super easy.

The first thing to do is just go and create an advisor agreement on SeedLegals. Anyone that you’re hiring as an advisor or a consultant or for anything, you always want to do an agreement. And of course, SeedLegals is a way to do it. Create an advisor agreement. You’re now going to say, well, how much equity should I give them? So here it might be the case that you think, alright, I’ll give them £10,000. If I was paying them in cash, I would give them £10,000 for a year of being an advisor on my board. That might be about ballpark. Let’s say my company valuation is £5 million, so £10,000 is 0.2%, so I’m going to give them 0.2% equity. So in my advisor agreement, I say, you’re going to get 0.2% equity in my company, vesting over one year.

Never give shares or share options without vesting; it may turn out the person isn’t any good, they leave after three months. So you want vesting, so great. So that’s basically all you need in an advisor agreement. And the advisor agreement will say the company is granting you share options pursuant to an unapproved option scheme as and when created by the company. So now you’ve got your agreement, you’ve got your advisor on board, it’s cost you nothing. You’re doing this as part of your SeedLegals subscription plan. And now at leisure, you can create your unapproved option scheme. Perhaps when you’ve got a bit more money, when you’ve got some money from your funding round, you can now create the scheme which creates the longer form paperwork and the grant, which will then the terms match in a longer form way, the full set of legals that match the promise you made in the advisor agreement.

To recap:

  • Shares are the way to go if giving a lot of equity to somebody and the shares still have no value and you want the person to have votes.
  • Growth shares are the solution when you want to give quite a lot of equity to somebody and you don’t want to avoid tax problems when the shares already have a value. You want them to have voting rights today. And they’re also the solution if the person receiving the equity doesn’t qualify for EMI options or the company no longer qualifies for EMI options or the person is outside the UK and so on and doesn’t qualify.
  • EMI options are the solution for employees.
  • Unapproved options are the solution for everyone else.

Growth shares are probably the most effort to set up and therefore the least used because the company has to modify the articles to support the distribution of profits on sale of the company with growth shares getting paid out after the others and so on. And you also need a growth share valuation.

Whatever you decide, you can allocate equity to your team really easily on SeedLegals.

If you have any questions just hit the chat bubble, we’re here to help.

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