If you’re planning to start an EMI share scheme for your business, one of the first decisions you’ll need to make is when your team can access their shares.
Your team’s options can be exercised to become shares in one of two ways:
- With exercisable options (sometimes called “exercise-based options”), which require completion of a vesting schedule and/or performance milestones, allowing your team members to exercise when the shares become fully vested; or
- With exit-based options (sometimes called “exit-only options”), allowing exercise when your business is sold, there is a change in control, or when another significant change in company structure occurs. A vesting schedule and performance milestones can be used in this case as well.
There are benefits and drawbacks to each approach, and you should know about them before making a decision.
This guide will help you understand the difference between exercisable and exit-only options for EMI share schemes so that you can make the right choice for your business and team.
Let’s first take a look at exercisable and exit-based options in detail so you can become more familiar with them.
How do exercisable EMI share schemes work?
If you choose to set up an exercisable EMI scheme, your team will be able to exercise their options at a pre-determined price in the future, typically over a period of time laid out in a vesting schedule.
Vesting schedules determine the following:
- If there is a waiting period, or “cliff,” before a team member is eligible to receive any options
- When and how often options vest, e.g. monthly, quarterly, or annually
- If there are any performance requirements to acquire vested options
Typically, vesting schedules are expressed to option holders as something like “1,000 shares available after four-year vesting with a one-year cliff, with options vesting monthly.”
How do exit-based EMI option schemes work?
With an exit-based EMI share scheme, team members only receive their shares in the organisation after the completion of any required vesting and an exit.
Exits are defined specifically in each option agreement, but typically include the following:
- The sale of your company to another
- A merger with another company
- A management buy-out
- A company buy-back
- A change in control
- An asset sale
- Floating on a public exchange
Although one is not required, exit-based EMI option schemes usually have a vesting schedule. In fact, we have found that a majority of Vestd customers will choose an exit-only scheme with a vesting schedule. This is so that if team members leave the organisation, they can keep these share options vested (if their agreement allows). It also gives employees the feeling of having achieved their shares over time, much like an exercisable EMI scheme.
Again, as with exercisable EMI option schemes, a vesting schedules determines:
- If there is a cliff
- When and how often options vest
- If there are any performance requirements
If a vesting schedule is present, even if a team member’s options fully vest before an exit occurs, an exit is required to exercise any shares - unless the option agreement gives the Board discretion to allow, for example, good leavers to exercise outside of an exit.
What are the key differences with exit-based exercising?
The biggest difference between time-based vesting and exit-based exercising is the requirement of vesting. If a vesting schedule is present in an exit-based EMI scheme, completing the schedule on its own will not award the employee any options: the company must still experience an exit before their options become exercisable and are converted to shares.
Exit-based schemes are typically chosen by companies who are working specifically towards being acquired or sold to another larger organisation. 76% of UK businesses using Vestd opt for exit-based EMI schemes, showing that the majority of our customers are anticipating an exit in the future.
Both exercisable and exit-based vesting allow you to receive seed funding and investments from outside sources. They also allow you to offer common shares to whomever you choose. This aspect of your EMI options scheme simply impacts whether or not an exit must occur before your team has access to their shares.
Are exercisable options or exit-based exercising the best choice for my EMI share scheme?
Choosing between an exercise- or exit-based EMI scheme should ultimately depend on whether or not you are working toward an exit in the future.
If you have no plans to sell your company, you should consider exercisable options. This way, your team won’t be waiting for something that may not happen, or working toward an unachievable goal, to receive their shares. The presence of a vesting schedule will also give your team a clear picture of how long it will be until they can receive and exercise their shares. It will also, philosophically, help you turn your employees into shareholders.
On the other hand, if you are working toward an exit, exit-based can be a better choice. Employees will work together toward the goal of a sale, and will look forward to receiving shares as a reward for their hard work. This choice will also fairly reward everyone involved with the process of preparing the company for an exit, no matter how long they have been an employee.
Regardless of the choice you make here, your EMI option scheme will be seen as a reward for the team’s hard work, and that’s what matters most.
Learn more about vesting schedules for EMI share option schemes
We hope this guide has helped you feel more confident about the EMI scheme you’re starting for your team, and the decision you need to make about when and how your team’s options will become available.
If you’d like to read more about vesting schedules, you can read our guide to choosing the right one for your EMI scheme right here. Or if you’d like to learn more about EMI share schemes before you get started, visit our EMI knowledge base here.