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Why grant options over existing shares?

Why grant options over existing shares?

Equity dilution, share dilution (or whatever you want to call it) is not inherently a bad thing. Not if it’s well managed.

Once you know how dilution works, you’ll know when it’s appropriate and when to avoid it. Not diluting shares your company has issued to investors is one such scenario. And that’s where granting options over existing shares comes in. 

Our COO, Simon Telling, explains dilution and its impact in far more detail here. But I’ll quickly cover what dilution is before we focus on the topic at hand as it’s important to wrap your head around.

What is share dilution?

Share dilution is the reduction of each shareholder’s proportion of equity each time additional equity is issued.

In other words, whenever a company gives out more shares to new investors or future employees, each person's slice of the ownership pie gets a little smaller. But a smaller portion is not necessarily any less tasty (stay with me).

Few startups can afford to bootstrap their way to success. One or more cash injections from an investor could help you achieve growth that would otherwise be impossible. And that investor will expect equity in return.

Funds aside, your talented team is the backbone of your operation. A company share scheme is not only a way to reward them for their hard work, but it’s also a fantastic incentive proven to boost motivation, productivity and loyalty - all crucial ingredients for growth - growth that could transform the value of your business. 

Would you rather have a little less of a much larger pie or a little more of a smaller pie? Food for thought.

While dilution can reduce the proportion of equity each shareholder has, value is the one to watch. Dilution is to be expected, and certainly not something to be afraid of.

When is it a problem?

Some founders don’t want their shares diluted, which is totally up to them. They think of sharing equity and imagine a huge reduction, which isn’t always the case; founders can give a little away and still retain a significant stake. 

Work out how many shares to give to employees and investors with our free calculator.

If anyone is likely to object, it’s an investor, as dilution will impact the return on their investment. Securing funds in the first place is tough, so you can see why a founder would be reluctant to bring it up with them. Early hires who are shareholders are likely to have a view too.

What can I do to minimise dilution?

If you’re in a situation where you want to minimise dilution, you have a few choices, most of which are covered in this article. But I’m going to walk you through the first one because it’s a pretty neat solution.

You can issue options over a specific individual’s shares. So instead of diluting everybody’s percentage ownership, you’re just diluting one person’s. Often, it’s the founder.

Let’s say that you are that founder. The benefits of doing this are:

  • You can create an option pool to award employees with options without diluting (and annoying) investors. Such as super tax-efficient EMI options!
  • Diluting your ownership by just a fraction to give your team skin in the game sends a powerful message - that you want them on this journey with you.

So instead of trying to increase the size of the pot, which would involve authorising and creating additional shares, you’re taking from the existing pot.

Good to know

If you go down this route, there are a few things to be aware of when the individual comes to exercise. 

To exercise is to turn options into shares by buying them at a pre-agreed price, the ‘exercise price’. 

To start this process, a stock transfer is required as those options technically belong to somebody else at the time.

When exercising over a shareholder’s shares, the option holder must pay HMRC stamp duty if the total exercise price is over £1,000. And instead of paying the company the exercise price, they’ll pay the shareholder themselves.

Read this guide for more information

How to get started

While possible, it’s the sort of thing you’d want a professional to take a look at. You could reach out to your lawyer (and spend a pretty penny) or you could talk to the equity specialists in our team and sign up to Vestd.

With our help, you can grant options over existing shares through the platform. We’ve got the templates ready and worked hard to make the process as straightforward as possible.

You’ll also benefit from auto-generated agreements, personalised certificates, digital signing and a secure document vault to store everything in, along with many other features

Join Vestd today!
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