Do you know the difference between shares and options? There’s a lot of information online but never enough time. To save you the trouble, we’ve put together this quick and easy guide.
We’ll explain what shares and options are, outline the differences between the two and share a few use cases. And include links to additional resources should you want to dive deeper.
Often, the two terms are used interchangeably (just to add to the confusion) but they are not the same thing.
So, first things first...
What are shares?
Have your cake and eat it too.
Picture a company as a cake, a whole one. When a company is set up, the cake belongs to the founder. They own 100% of that cake. It would be pretty greedy to keep all that cake to themselves, wouldn’t it?
Usually, that cake is cut into a certain number of slices. Or rather shares. A company can have any number of shares, and the nominal value of those shares is decided by the founder(s) or director(s) as more people come on board.
Essentially, shares represent ownership of a company. And every limited company in the UK is made up of shares. Generally speaking, shares are available immediately, meaning that shareholders (those receiving shares) can have their slice of cake and eat it right away.
There are different types of shares. This is where it gets a little more complicated so we won’t go into detail. But it’s worth knowing the top two types that people talk about: Ordinary Shares and Preferred Shares.
What are options?
Save a slice for later.
Instead of sharing a slice of the cake with shareholders immediately, founders/directors can award options instead. The recipient of those options has the right to convert (exercise) those options into shares at a later date or on exit, at a pre-agreed price.
So essentially, options can one day become actual shares in a company. You’ve been saved a slice for later.
Not hungry? No problem. While recipients have the right to exercise their options, they are not obligated to do so.
It’s worth mentioning that options are subject to specific conditions. Options can't be awarded or vest (grow in value) until a performance-based or time-related milestone is reached. E.g. Generated ‘X’ amount in new revenue or worked at said company for ‘X’ number of years.
Any conditions should be tangible, measurable, specific and agreed upon by all parties first.
What’s the difference between options and shares?
If you’re a recipient:
- Shares - you get a slice of equity now
- Options - there’s a slice with your name on it to have later
That’s the fundamental difference between shares and options. The former allows someone to become an immediate shareholder and the latter gives someone the right to turn options into shares in the future.
It’s up to the founder(s)/director(s) to decide when and how equity is released to reward those that help the business grow, i.e. employees, advisors and contractors.
And that’s precisely what sharing equity is all about; aligning, engaging, motivating and rewarding teams.
There are a few reasons why some companies choose to award options instead of shares:
- Tax advantages
- As a way to incentivise
- As a way to improve retention
With HMRC-approved employee option schemes like Enterprise Management Incentives (EMIs), both employee and employer benefit from huge tax advantages.
Employee option schemes are proven to incentivise employees over time and improve retention rates if there’s a vesting period in place. In fact, in a recent survey, 95% of Vestd customers said that EMI has actively helped to improve employee loyalty.
There are various types of share and option schemes designed to suit different business needs.
So, that’s it. A basic introduction to shares, options and the differences between them in plain and simple English.
After all this talk of cake, if you’re hungry for more information, book a free consultation today with one of our equity specialists.