Share options explained: the essential guide for UK startups

Share options schemes are a popular way to attract, retain and incentivise employees. Thousands of UK startups use share options schemes to build and grow their business every year.

In this article, we’ll explain what share options are, the different types of share option schemes and how to set up a scheme for your company. We’ll also look at the tax implications of share options and how to make your share scheme cost-effective.

Should I give shares or share options?

To share equity with your team, you can offer them shares or share options. What you decide to offer will depend on your company and the contribution your team member will make – either way, it’s important to understand the difference between shares and options:

• Shares give the holder a percentage of ownership of a company. When a company issues someone ordinary shares, the recipient immediately owns those shares.
• Share options give the holder the right to buy shares in your company at a fixed point in the future. The holder of share options does not yet own the shares.

Read more in our post: Shares vs options: what’s the difference?

What is a share option scheme?

A share option scheme is a way to distribute share options to employees, advisors, freelancers and consultants. Team members who receive share options can exercise their options at a later date and convert their options into shares and own equity in the company. Giving share options can be a great way to motivate your team – it gives them a personal interest in the success of your company.

There’s a lot to consider when it comes to setting up your share option schemes, such as how much equity to give employees or how much equity to give advisors and which option scheme is right for you.

It’s a tricky balance for founders. How do you decide how much equity to give away when you don’t yet know how much value option holders will bring to your company? The brilliant thing about share option schemes is that you design your own. You can make your scheme work in the best interests of your company and your employees by setting the parameters and customising the terms to fit your company exactly. It’s a neat, controlled way to reward your employees and helps you avoid giving away too much equity too soon.

What are the benefits of share options?

Motivated, talented employees play a major part in your success, so making your company a rewarding place to work is in everyone’s best interests. Here’s how offering share options can be a big advantage, not just to your team but to the company as well:

• Attract and retain talent 🌟
  Share options can be an enticing opportunity for employees, consultants and advisors to earn extra income on top of a salary. If your company succeeds and the shares become worth a substantial amount, your options holders could sell their shares for thousands of pounds. This can be a tremendous incentive and make your company more attractive to employees.
  Because you can only exercise options after a certain period of time or after a milestone is hit, options can also motivate employees to stay at your company for years.
• Boost productivity 🚀
  When team members have a financial interest in your company’s success, they’ll have more drive to do their best – and when your employees perform better, your company performs better. With their share options vesting every month, team members have an extra incentive to work towards their goals.
• Enhance company benefits (in a cost-friendly way) 💰
  Share options are a cost-effective way to enhance employment packages at your company. Yes, there’s a cost involved to set up and run the scheme, but the reward for employees can be far greater than the cost to your business. If you’re smart about how you set up and run your scheme, share options can add to benefits without draining your cash flow.

Who can I give share options to?

You can give share options to employees, advisors and consultants – and even customers and influencers too.

• Employees
  Share options are most commonly given to employees as a way to attract, retain and motivate talent. You’ll need to think about how much equity you want to give them. Usually, startups set aside 10% – 15% of total company equity for employees.
  Read more in our post: How much equity to give employees
• Advisors, consultants and freelancers
  Share options aren’t only for employees – you can also attract talented advisors, freelancers and contractors to your company by awarding equity. Our data shows that startups usually give 1% of equity to each advisor. This will come out of the 10%-15% equity set aside from your share options pool.
  Read more in our post: How much equity to give advisors
• Customers and influencers
  Some companies like to incentivise customers and social media influencers with share options. Offering options is a great way to thank customers for their loyalty and to reward influencers for helping the company gain customers.
  The most important thing to know about giving options to customers and influencers is that there are complex tax rules and securities laws when it comes to giving equity to these groups of people. Make sure you discuss it with a qualified lawyer if you’re thinking about doing this.
  Read more in our post: Giving options to customers and influencers

When should I set up an options scheme?

The optimal time to set up an options scheme is when you want to do one or both of these:

1. Raise funds

Set up your scheme before a funding round to become more attractive to investors. You might want to consider getting your EMI valuation at least three months before you start to fundraise so that you can get a low strike price for your future employees.
Read more in our post: When is the right time to put an EMI Scheme in place?

2. Grow your team

If you have your options scheme in place before you hire, you can highlight this perk for employees to attract job-seekers.

What is a share option pool? (And why do I need one?)

To set up a share option scheme, you’ll need a share option pool. A share option pool is a percentage of equity that you set aside for your share option schemes. The average size for share option pools in the UK is 10 to 15% of total equity. You can give options to employees, advisors, consultants as well as customers and influencers – all from the same share option pool.

Read more in our post: How to size an employee option pool

What are the different types of share schemes?

‘What’s the best type of employee share scheme for startups?’ This is a question we’re asked all the time. Our answer is simple: an EMI option scheme is the best for giving options to UK-based, full-time employees. This is because it’s the most tax-efficient scheme for both companies and employees.

There are two types of share option schemes that are the most useful for UK startups:

EMI scheme

This type of scheme is backed by HMRC and designed for UK-based PAYE employees who work for your company for at least 25 hours a week or 75% of their working hours. The EMI scheme has significant tax advantages for both the employee and the company. Below, we’ll explore how tax works for share option schemes.

EMI scheme pros

Employee tax benefits –  your employee won’t pay Income Tax or National
Insurance Contributions when the options are granted. After exercising their options and holding the shares for over two years, they may qualify for Business Asset Disposal Relief, which reduces Capital Gains Tax from the standard rate (currently 24%) to 14% on qualifying gains.

Employer tax benefits – you get a Corporation Tax deduction on the difference between the market value of the shares at exercise and what your employee pays for them.

Set your own terms – you can protect your company by choosing
exact terms for vesting and exercise provisions. Bear in mind that there are some constraints on when the option can be exercised to benefit from the EMI treatment.

EMI scheme cons

Limited EMI options value – you can only grant up to £3M of EMI options in total and up to £250,000 to an individual. This limitation on the value of options is why it’s important to set up your EMI scheme early and get the best valuation possible.

Restricted to UK  full-time employees – not available to employees based outside the UK or non-PAYE team members, like consultants, advisors and contractors.

Extra admin – as well as agreeing the valuation and exercise price with HMRC upfront, you have to register every option grant within 92 days. This can be a headache, but if you set up your scheme through SeedLegals we’ll give you all the support you need to keep everything compliant.

Unapproved scheme

This scheme is for everyone the EMI scheme doesn’t cover and for companies that aren’t eligible for an EMI scheme. An unapproved scheme is perfect for giving options to employees abroad – we explain more in How to give share options to overseas employees.

Unapproved scheme pros

Flexibility – you’re free to set an exercise price and there’s no limit to the number or value of the options you can grant in total or to an individual.

Less admin – don’t have to go through a valuation process with HMRC.

Set your own terms – you can protect your company by choosing exact terms for vesting and exercise provisions.

Unapproved scheme cons

No tax benefits for employees –  there is no special tax treatment for unapproved option holders.

No tax benefits for employers – there is no special tax treatment for companies.

While other HMRC-approved option schemes are available, they don’t offer either the tax benefits of the EMI or the flexibility of an unapproved scheme.

Companies that don’t qualify for an EMI scheme could consider growth shares. This type of shares only have a value when the company’s share price goes over a certain amount. Growth shares are a way to incentivise employees with equity either without an option scheme or separately from your option scheme.

Read more in our post: Growth shares: what are they and should you issue them?

How to set up EMI and unapproved options schemes

1. Check eligibility

If you want to set up an EMI scheme, the first step is to find out if you’re eligible.

Your company is eligible for EMI if:

• It is permanently based in the UK
• It employs fewer than 250 full-time employees
• It has £30 million or less in gross assets
• It is an independent company, not owned by a parent or holding company
• It only has subsidiaries that also meet the EMI qualification requirements
• It is a commercial company that does not operate in certain industries

Your employee is eligible for EMI options if:

• They are a legal employee of your business
• They work at least 25 hours a week or 75% of their weekly working time
• They hold less than 30% off all company shares
• The total market value of the options they hold doesn’t exceed £250,000
• Your company hasn’t already granted over £3 million in EMI options

For the unapproved scheme, there are no eligibility requirements from the government. However, if you’d like to set up an Unapproved Scheme on SeedLegals, to be eligible, the option holder has to be an employee, director, advisor or consultant at the time of grant (past employees, directors, advisors or consultants who don’t currently provide services to the company are not eligible).

2. Create an option pool

You need to agree on the option pool size with your shareholders and investors. It’s usually 10-15% of the shares in the company.

3. Get your HMRC valuation (EMI only)

Register your scheme with HMRC and submit your EMI valuation. This contains a proposal for the price your employees will pay to exercise their options.

4. Set your terms

Decide which vesting and exercising rules you want to include in your scheme. If you’re using SeedLegals, decide whether you want to use time-based or milestone-based vesting.

5. Grant options

If you use a digital platform like SeedLegals, it’s easy to get everything signed and to issue options certificates.

6. Notify HMRC about the grant

You must notify HMRC within 92 days of the date you grant EMI options, and unapproved grants to UK tax-paying employees and directors need to be notified as part of your annual report due by 6 July.

In practice, many companies use both an EMI scheme for their full-time UK-based employees and an unapproved scheme for anyone who falls outside the eligibility criteria, such as anyone outside the UK or consultants, advisors and non-executive directors.

What are the tax implications of share options and option schemes?

EMI schemes are the most tax-efficient share option scheme for UK employees and employers. Below we explain how tax works for EMI and Unapproved options:

EMI options: Tax implications for employees

Employees don’t need to pay Income Tax or National Insurance Contributions when EMI options are granted. And, assuming they exercise their options at the pre-agreed valuation with HMRC, those taxes are not due on exercise either.

When they later sell their shares, they may qualify for Business Asset Disposal Relief, which reduces Capital Gains Tax from the standard rate of 24% to 14%, provided they’ve held the shares (including time under option) for at least two years.

EMI options: Tax implications for companies

With an EMI option scheme, when your employee exercises their options your company can claim a Corporation Tax (CT) deduction equal to the financial gain of your employee. This gain is the difference between the market value of the shares at exercise and the amount your employee pays for them. It’s essential to consult your accountant or tax advisor to ensure the valuation and structure of your option grant are correctly handled. This helps avoid the risk of unexpected tax liabilities for either the company or your employees.

Unapproved options: Tax implications for employees and companies

With the unapproved scheme there are no tax benefits for employees or companies. The only advantage is that tax is delayed until shares are exercised – your options holders don’t owe any tax when you grant their options.

How much does it cost to set up an option scheme?

This depends on how you choose to go about it. There are two ways:

1. Hire accountants and lawyers to take care of it
2. Use software services – ideally one that combines automated document creation with experienced support

If you choose to hire accountants or lawyers, it usually costs upwards of £5,000 for one scheme, plus extra admin fees.

At SeedLegals we offer personalised help from our experienced team alongside all the tools and documents to set up your scheme – automating the legal admin means our pricing is very efficient.

With SeedLegals, you can fix your options costs for the year at just £2,490 per year.

This includes:

• Unlimited EMI share option schemes for UK-based, PAYE employees
• Unlimited EMI valuations to get the best possible discount for your team
• Unlimited Unapproved option schemes for advisors, consultants and anyone based outside the UK
• All the legal documents you need to ratify your scheme (including board and shareholder resolutions, option agreements and SH01s)
• Option holder dashboard for your team to view and manage their options

Find out more:

• SeedLegals share option scheme service
• Our pricing

For employees: Share options explained

Has your company offered you share options? In this must-watch video, Anthony Rose, CEO of SeedLegals, explains what share options are, how options vest and exercise work, how to work out how much your options might be worth, the tax advantages of EMI options, and more.

Key takeaways

• There are important differences between shares and share options. Options give the recipient the right to buy shares in future at a pre-agreed price.
• Share options can be an effective incentive to attract and retain talented employees. They can also motivate your team, boost productivity and create cohesion in your company.
• You can give share options to employees, advisors, consultants and even customers and influencers. You can also give options to overseas employees with an Unapproved scheme.
• It’s a good idea to set up your options scheme before a funding round and/or before hiring employees when scaling up.
• The two most relevant types of share option scheme for startups in the UK are EMI and Unapproved.
• EMI options are for full-time PAYE employees and are tax efficient for employees and the company
• Options from Unapproved schemes can be granted to people not eligible for EMI options.
• Options schemes often cost upwards of £5,000 to set up if you use a lawyer or accountant. You can also choose to set up your schemes with an online service such as SeedLegals.

Talk to the SeedLegals team

If you’ve got questions about how to set up a share option scheme, book a call with one of our experienced  team to get answers fast.