Giving someone equity? This interactive bot will help you figure out the exact legal docs you need! Alternatively, continue reading below for the full details.
For startup founders, company equity (a.k.a. shares) is a precious commodity. It needs to be given away sparingly. It’s divided amongst co-founders, used to incentivise early team and advisors, and exchanged with future investors until the company is able fund its own growth sustainably. Give away too much in early stage rounds, and you’ll have none left for future investors or employees! At SeedLegals, we know the average equity amount given to investors is 15% at each round.
But it’s not just the amount of equity you give away that matters, but the method in which you do it too.
Give your new CTO equity with the wrong way, and they may end up not legally owning the shares at all, or worse still, it might land them and your company with massive tax bill!
For investors, it’s simple. You can give them shares by creating investment agreements either by doing a funding round, or creating an Advance Subscription Agreement.
But for co-founders, employees, advisors, consultants and Directors things get a little trickier.
Decide whether to give shares or share options
Whereas you’ll give equity to investors in the form of shares, for everyone else you will have the option to give share options instead. Typically you’d only ever give shares to co-founders, and issue share options to employees and other advisors.
Giving someone shares means they become a shareholder immediately. This means they’ll instantly have voting rights, the ability to influence key company decisions and even rights to some of the companies assets in the event it shut down.
Adding extra layers of bureaucracy to any company is a breeding ground for inefficiency, and can cause grid-locks if all voting shareholders fail to agree on high level decisions. In a startup, moving fast is mission critical, so shares are typically reserved only for co-founders, and investors once the company raises funding. Everyone else gets share options.
Share options have two major long term benefits for your company, and they’re both due to the fact that share option holders don’t become shareholders right away. Share options convert to shares in the future, and typically convert into non-voting shares. Share options are also earnt over a period of time, known as the vesting period. This means that employees are incentivised to stay at the company, so their share options ‘vest’.
Here’s a more in depth look at the difference between shares and share options to help you decide.
If you have previously raised equity investment, or are generating substantial revenues, you might be far better off issuing share options instead. This is due to the fact that your company now has a ‘value’:
If your company has a ‘value’ you’re usually better off giving share options
Typically early stage startups are pre-revenue and pre-funding, and shares aren’t recognised as having a value in the eyes of HMRC.
However, this changes as soon as you start raising funding or generating substantial revenues. And once your shares have a ‘value’ they are deemed as a taxable benefit by HMRC, so any shares allocated to someone past this point would be subject immediate taxation, which is far from ideal!
Example: Hunter gets issued and allocated 1,000 Ordinary shares, and is asked to pay the nominal value of just £0.01 per share. However, since those shares have a market value of £20 each according to HMRC (based on a recent investment round, or trading history) – the £19.99 difference would be taxable immediately. Amounting to £19,990 of taxable income for Hunter.
So if you’re pre-revenue / pre-funding, you can go ahead and give someone shares using this step-by-step guide.
If not, there are 3 scenarios in which your company will have a value, and share options will be your best bet:
1) You’ve raised funding – a valuation is agreed at a funding round
2) You’re raising funding now and you have a signed term sheet with a valuation on it
3) You’re generating substantial revenue, or are profitable
In these cases, it’s almost always advisable to set up an Option Scheme, and issue share options instead.
Share options aren’t taxed when they are issued, or vested, rather all taxation occurs at the point at which they are exercised, which in most case will be at an exit event.
How to give out share options
There are 3 parts to giving out share options.
Firstly, you’ll need to sign an agreement with your team member where you promise them share options, which includes details of vesting provisions. At SeedLegals, all our employment and advisor agreements contain sections for you to detail share options and vesting. You can create it right now for free on SeedLegals’ 7-day free trial.
Second, you’ll need to create a Share Option Pool. This means reserving a portion of company shares that can be created and allocated in future. If you’ve previously raised funding, the best time to create a new option pool is ahead of a funding round. This is because existing investors will get diluted and new to approve it. And since they’ll already be approving the creation of shares for new investors – you’ll kill two birds with one stone!
You can create a share option pool easily in your funding round on SeedLegals.
Thirdly, you need to set up a Share Option Scheme. A Share Option Scheme is a set of rules that govern how and when your options can be exercised (turned in shares), and most importantly the tax implications around that.
For employees and directors
There are a number of different share option schemes out there. But the most popular by far is an EMI Scheme, and with good reason. An EMI Option Scheme allows you to grant options to qualifying employees worth up to £250k (each employee) without giving rise to an income tax or NIC charge.
For advisors and consultants
For everyone else you can go ahead and give out share options, either without a scheme or by setting up an Unapproved scheme. An Unapproved Scheme is a fantastic way to formalise the giving of options to employees who might not otherwise qualify for an EMI Option Scheme, such as part time employees working under 16 hours a week.
You can set up both an EMI Option Scheme and Unapproved Scheme easily on SeedLegals.
How to give out shares
In order to allocate new shares in your company, you’ll need your existing shareholders to sign a Written Resolution for the Allotment of New Shares. (Use this Written Resolution template!) This document is needed for founders/Directors to gain permission from existing shareholders to create new shares.
Once you have consent from shareholders, (and sometimes you’ll need an Investor Consent notice.. More on that here), you’ll need to file an SH01 at Companies House. Create an SH01 for free on SeedLegals’ 7-day trial.
Lastly, issue your new shareholder with a share certificate, which you can also do from your SeedLegals dashboard.
And that’s it – you’re good to go!
If you have any questions, or still aren’t sure on the best way to go – here’s a more detailed article on how to give someone shares and how to give share options. or feel free to get in touch and book some time with an expert, we’d love to help!