Your company has offered you shares or options. Great! Though you might be wondering: now what? What’s really in it for me? When do I get to reap the benefits?
In this article, we’ll explore the potential of your shares and the kinds of choices you could make to get the most out of your equity compensation package.
But first, why give away equity in the first place?
Why do companies give employees shares?
Companies can use equity as a form of compensation. To attract new talent to the team and reward those who contribute to the success of the company.
Popular with startups, an employee share/options scheme is a cost-effective (and often tax-efficient) way to incentivise teams instead of scraping together a salary they simply can’t afford as a burgeoning business. Or promising huge bonuses.
But there’s more to it than that. Time and time again, companies that offer employees shares and options see seismic improvements across the board.
Employee share schemes help to:
- Attract talent
- Decrease employee turnover
- Boost productivity and performance
- Enhance engagement and employee happiness
- Increase overall business value
- And, as we mentioned, relieve cash flow pressure
In response to the UK Government’s call for evidence regarding Enterprise Management Incentives (an employee options scheme), we asked our customers what impact their EMI schemes had so far on their businesses.
- 93% of existing customers confirmed that EMI helped recruitment efforts
- 95% agree that EMI helped with retention
- 93% believe that EMI has helped their company grow and develop
- 93% said that EMI enhances their company culture and aligns teams
With all that in mind, you can see how an employee share scheme makes perfect sense. But there’s a deeper, philosophical reason why sharing equity makes businesses better.
Giving employees shares and options gives them skin in the game, a slice of the action, an opportunity to be part of something bigger. We call this the Ownership Effect.
Why should only the board of execs benefit the company’s success? Why not the people who helped make it a success? The team.
It’s about time we moved away from an obsession with cash and focused on creating a fairer equity economy. And one that’s more accessible. That’s where digital equity management comes in.
But back to the topic at hand. Your company has allocated you a number of shares or options. What can you expect to happen moving forward?
The lifecycle of shares and options
What happens to your shares depends largely on the type of shares, the scheme criteria and the specific agreement you have with your employer.
Let’s say you’re awarded options under the EMI scheme. The lifecycle of your options might look something like this:
*Recipients qualify for Business Asset Disposal Relief (formerly known as Entrepreneurs' Relief) so long as they don't sell the shares within 24 months of the option grant. More on tax and EMI.
Not all timelines will look the same. Though, it is likely that your employer will impose conditions such as a vesting schedule or targets to meet before equity is released.
It’s only fair when you think about it. Otherwise, the company risks giving away chunks of equity to those whose hearts aren’t really in it. But if you are committed and thinking long-term, the reward is worth the wait.
What to do with your shares/options
When there is an exit
Let’s fast-forward. Everything has gone to plan. You’ve been a part of something big. So big in fact that the company is anticipating an acquisition, merger or sale, or is ready to go public.
You’ve got a few options. Either you can exercise your options and keep all or some of the shares in the hopes they grow in value or choose to sell them when possible.
A few things you need to know (or find out) before making any decisions about your employee shares or options:
- What type of share/options?
- Exit-only or exercisable?
- What are the tax implications?
The details of the employee share scheme itself and the type of shares/options offered will determine the tax treatment that you can expect to receive.
You could be eligible for Business Asset Disposal Relief or discounted Capital Gains Tax, for instance. These kinds of tax perks are subject to conditions and time restrictions too.
In the case of EMI, the company can stipulate whether or not their scheme is exit-based. That means an exit event must take place before recipients can exercise their options in addition to any other criteria.
The alternative is an exercisable agreement. You need to know which one applies in your case.
When there is a liquidity event
Not every company is heading for an exit. Which begs the question, how will I ever exercise my options if the company isn’t looking to sell in future? Fear not, as well as offering exercisable (not exit only) options, some employers create liquidity events.
By that, we mean an opportunity (or multiple opportunities) to exchange any shares you’ve already exercised for cash before the vesting period is complete.
That money could be put towards something you need now or in the near future, like a car or a deposit on a house, for instance.
For example, let’s say you have 8,000 shares vesting over four years with a one-year cliff.
- Year 0 (cliff) - 0 shares
- Year 1 - 2,000 shares
- Year 2 - 2,000 shares
- Year 3 - 2,000 shares
- Year 4 - 2,000 shares
By the end of year four, that’s 8,000 fully vested shares. But the company may allow you to cash in a certain amount on an annual basis. In this instance, 2,000 shares each year in exchange for cash.
Or opportunities could be less frequent. Regardless, you will need to double-check what’s possible with your employer. Liquidity events may not be possible. It really depends on the business, cash flow etc.
When it’s time to go
There comes a time for all of us to move on, take a break and find pastures new. And after all that hard work, you certainly don’t want to walk away empty-handed.
And you shouldn’t. In the case of an employee option scheme, any options you’ve exercised are yours. You have total ownership of those shares. Though be mindful of any ‘drag along’ or ‘tag along’ clause in your options agreement.
To make the most of your shares/option, you need to make a note of:
- When the vesting period ends
- How much has vested already/how much is left to vest
- How many shares you’ve exercised already
- Any time limits/restrictions
If possible, plan your departure date with the vesting period of your shares/options in mind. You’ll look back and kick yourself if you realise that if you had just waited a couple of weeks, you would have passed another milestone and got an even bigger slice of the pie.
Depending on the employee share/options scheme itself, there may be time limitations to exercise options or restrictions on when and how you sell any shares that you own.
For instance, under the EMI scheme, employees must hold their equity for at least 24 months after the grant date to be eligible to pay only 10% Capital Gains Tax (instead of the standard 20%) at sale, over and above the value when granted.
What happens to my shares if I don’t meet the criteria?
Sometimes, things don't work out. Again it depends on the scheme and type of shares, but generally speaking, any allocated shares/options not exercised become deferred shares (effectively, cancelled).
The company won’t lose anything, as until the options are exercised, they hold no inherent value.
What happens if I can’t afford to exercise my options?
Not everyone is in a position to exercise their options at the right time. Know that participation in an employee option scheme is not compulsory. You have the right to exercise options if you want to, but you are not obligated to do so.
Say you do want to exercise those rights, but money is a little tight. One way to solve this problem is to ask the company if you can exercise your options at another point in time. They could create another opportunity, a bonus round.
We hope you now have a better understanding of what’s possible for your shares or options. Talk openly to your employer, and don’t be afraid to get into the nitty-gritty of your shares/options agreement to get the most out of your equity compensation package.