Key terms, tax benefits and My Equity.
First of all, congratulations! You’ve been granted a CSOP – or Company Share Option Plan.
Depending on the future growth of the company, your CSOP could turn into a life-changing sum. Plus it shows the company values your hard work.
But you’re probably wondering, what does all this mean? Here we’ll explain the top 5 things you need to know about your CSOP.
1. Your option agreement
This is the contract between you and the company that has granted you the options. It contains all the legal details and outlines what you need to do to ‘earn’ your options, such as your time or performance-based conditions, vesting schedule, exercise price and exercise conditions (more on all this later).
When you get familiar with the key terms we’re talking about here, your option agreement will be your go-to for any questions you may have.
2. Key terms
As we alluded to above, there are quite a few terms surrounding options that you may or may not be familiar with. So let’s get into what they all mean.
Options are a type of conditional equity. You have been granted the ‘option’ to purchase shares in the company, so long as you fulfil the conditions in your option agreement, both in terms of when they vest and when they can be exercised.
Vesting is how you ‘earn’ your options. As you fulfil the conditions of the option agreement (these can be time or performance-based conditions) your options vest and become yours to keep*. How your options vest will be determined by your vesting schedule…
Your vesting schedule is the timeline over which your options vest. For example:
- The options vest over a 4-year period, with 25% vesting each year.
- The options vest over a 1-year period, with 25% of options vesting each quarter IF quarterly revenue targets are hit.
Every time a set of options vest is called a tranche. These tranches can be monthly, quarterly, yearly, or based on key performance milestones.
Your vesting schedule may contain a cliff, which is essentially a waiting period from when you accept the option agreement to when the first tranche of options vests. For example, a 4-year vesting period with a 1-year cliff.
When you log into Vestd, your agreement summary page will outline all of the above.
*Vested options are yours to keep for as long as you remain employed by the company. If you were to leave, your vested options would be processed in line with the ‘good leaver’ clause in your agreement (for example, “keep vested options,” “exercise vested options” or “lose everything”).
Exercising
Don’t worry, you won’t be asked to do 100 squat jumps in return for equity.
Exercising is the process of converting the options into real shares. You are exercising your ‘option’ to buy the shares.
When your options vest, they may or may not become immediately exercisable.
Your option agreement will contain the exercise condition. This will either be:
Exercisable: Great news, you can exercise your options as and when they vest. Whether that’s per tranche or all together at the end of your vesting schedule, it’s up to you!
Exit only: Your vested options only become exercisable when the business goes through an exit event. This can either be a sale, merger, management buyout, company buyback or IPO.
The great thing about exit only schemes is that they can be made a ‘cashless exercise’ – meaning once your options are exercised, the shares are immediately sold, so you don’t have to fork out for the exercise price. Just enjoy the profit!
Now you may be thinking “there aren't any plans to sell the company, I’ll never be able to exercise my options!” Fret not, as it’s likely the company has set it to ‘Exit only’ for a reason – and while they may not be thinking of selling now, a lot can change in a few years.
And when the time comes, you’ll need to pay the exercise price.
3. Exercise price
This is the predetermined price per share you’ll need to pay to exercise each option.
The idea is that throughout your vesting schedule, you’ve helped the company grow, which has increased the company’s share price.
But rather than having to pay the current share price to become a shareholder, you pay the exercise price based on the company value when you first accepted the option agreement.
For example, your exercise price is £1 per share. 4 years later, once all your options have vested, the company is worth £4 per share. You will only pay £1 per share for shares that are actually worth £4! Talk about a good deal.
But what if the share price goes down? Fair question, and it’s entirely possible that things don’t quite work out.
Luckily, you have the ‘option’ – not the ‘obligation’ – to exercise. So you don’t have to if you don’t want to.
Once you exercise you will become a shareholder, and then you sell your shares immediately (as per the “Exit only” condition), or you hold the shares and watch the share price grow (hopefully) even more. It’s worth adding that if your exercise condition is “Exercisable,” you can sell your shares whenever you like – be it an exit event or private buyer – as long as there is a willing buyer.
4. Tax
Great news, your CSOP is a tax-advantaged form of equity – and as long as you meet the qualifying criteria of CSOP, you will only owe Capital Gains Tax (CGT) when you make a taxable profit (i.e. sell your shares).
So what do you need to do to make your CSOP qualify?
- Exercise the CSOP at least 3 years after (but within 10 years of) your grant date.
Yep, it is that simple. Just hold your CSOP for at least 3 years before exercising. Of course, you may have to remain employed by the company, as a condition of exercise – but when you hold equity in the company, you’re vested in its success and are more likely to stick around to cash in your shares.
There are a few caveats that allow you to exercise your CSOP within 3 years and retain the tax benefits, such as:
- If the company goes through an exit within 3 years of your grant date, the CSOP will still qualify and you will only be liable to CGT on any profit from the share sale.
- If you leave the company for one of the 6 exemption clauses (and your agreement includes these clauses).
If the CSOP doesn’t qualify for the tax benefits – for example if you exercise within 3 years but don’t meet one of the conditions above – then you will owe Income Tax on the difference between the exercise price and the market value of the shares at the time of exercise.
We go into much more detail about CSOP tax, including the different qualifying and disqualifying scenarios.
5. My Equity
Now all the legal stuff is out of the way, let’s talk about the exciting part – My Equity on Vestd.
In the past, share schemes like yours were just long, boring contracts nobody understood.
But Vestd works with thousands of companies to digitise their share schemes and help employees like yourself understand the real value of their equity.
My Equity shows your CSOP in a way you understand. Simply enter a future value and the graph will show you how much your shares could be worth.
There’s also a dynamic tax calculator that works out your tax liabilities and potential profit based on the information in the graph above and the type of equity you hold.
To learn more about how the My Equity graph works, we go into great detail about all the features here.