Shares vs options: what’s the difference?
It’s the classic problem for ambitious startups: you want to attract top talent to help you grow your business, but you...
Startup equity is a precious commodity and should be given away sparingly. Equity is 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 by our users 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.
But for co-founders, employees, advisors, consultants and Directors things get a little trickier.
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 shuts 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. Mostly 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 earned over a period of time, known as the vesting period. This means that employees are incentivised to stay at the company, because the longer they stay with the company, the more of their share options ‘vest’.
Here’s a more in depth look at the difference between shares and share options to help you decide.
How to give out share options
There are 3 parts to giving out share options.
First, 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 new funding round. This is because existing investors will likely have to approve the allotment of new shares. Since they’ll already be approving the issuance of shares for new investors, you can take this opportunity to ask your shareholders to approve the shares you plan to reserve for your Share Option Pool. In this way, you only need to pass one resolution rather than having your investors pass another resolution again.
Second, 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).
Third, you’ll need to sign an agreement granting your team member share options, which includes, among other things, details of when the options would vest and how they can be exercised.
While it is possible to do things in another order (e.g., granting options before you’ve set up a Share Option Pool or a Share Option Scheme), we would recommend doing things in the order described above to keep the documentation simple.
In order to allocate new shares in your company, you’ll need your existing shareholders’ approval and consent to create and allocate the new shares.
Once you have consent from shareholders (and sometimes you’ll need an Investor Consent Notice in case you have granted Investor Consent rights to some of your investors) you’ll need to work with your company/corporate secretary to (or on your own) issue and register the shares.
And that’s it – you’re good to go!
Previously setting up an option scheme was complex, time-consuming and expensive. At SeedLegals, we’ve made it dramatically easier. And as with all SeedLegals services, we’re on hand to help every step of the way.
If you have any questions, or still not sure on the best way to go, we’re here to help. Get in touch with our team who will guide you and help you get started.
*Disclaimer: The information contained in this article does not constitute and should not be treated as legal, tax, accounting, or financial advice.