Share option agreement solicitors

A share option agreement is an agreement between the holder of shares and a third party giving one party the right (but not the obligation) to purchase or sell shares at a future date, at an agreed price. If the option is exercised, the other party is obliged to purchase or sell those shares. The purchaser has a contractual right to become a shareholder.

Why do companies use share options?

The key reasons for share options are typically financial and motivational. Employee share options can be a tax-efficient way to remunerate employees. A company may therefore introduce a share option scheme to reward one, several or all of its employees. The scheme will be governed by a set of rules that address issues such as:

  • How many shares a participant can buy.
  • When the participant can buy the shares (exercise the option).
  • The price that the participant must pay for the shares.
  • Any conditions required for the participant to exercise the option.
  • What happens if a participant leaves the company.

A share option may also be used to permit the owner of a business to buy back shares in his company which he had previously transferred to an investor or to allow an investor in a company to make an exit.

Common features of share option schemes

Unless an employee is being rewarded for past performance, share option schemes usually require employees to wait for a certain period of time before they can exercise their options and buy shares. Three years is common. Alternatively, the right to exercise the option may be triggered by an event.

Usually, the conditions of the scheme prevent the participants from being able to sell or transfer their options to someone else.

The scheme should provide for what should happen if a participant leaves the company. Often the rules will differentiate between someone who is a “good leaver” (this could, for example, be someone who is made redundant) and someone who is a “bad leaver” (this could, for example, be someone who commits misconduct).

It is common for scheme rules to include provisions whereby the option will lapse in certain circumstances. These could include where the participant is a “bad leaver” or does not exercise the option within a certain time period.

Tax

The starting position is that an employee who exercises an option must pay income tax on the value of the shares they acquire. The liability is assessed on the basis of the value of the shares less the price paid for them. National insurance contributions (employee’s and employer’s) can also apply in specified circumstances, although it is possible to structure an option so that any employer NICs costs are passed to the employee.

However there are some arrangements that are tax advantageous. These are:

Under these schemes the employee can benefit from not having to pay income tax or NICs. Instead, capital gains tax may apply when the shares are sold.

The employer company may be entitled to a corporation tax deduction equal to the amount on which the employee pays income tax (or would have done if the option were not tax-advantaged).

What should I put in the agreement?

The contents of a share option agreement will largely be down to the parties. A standard share option agreement will typically set out detailed terms in respect of the shares, the option and the circumstances in which the option can be exercised. Such terms will include:

  • The shares subject to the option.
  • Any payment to be made on grant of the option.
  • The period in which the option can be exercised.
  • The option price and how it is to be calculated.
  • Any circumstances in which the option will lapse.

Our Share option agreement solicitor Suzy Giele can help you with any question.