The rise of the unicorn and start-up economy has turbocharged business ownership.
As a result, offering shares and options has become prevalent across the British business landscape. Nowadays, it’s common for eager entrepreneurs to attract new hires with share options or direct ownership into the company.
Nevertheless, shares and share options are commonly misunderstood, with one often being mistaken for the other. As they grow in popularity, it is important to familiarise yourself with the key differences between shares and options to determine what is suitable for your company to offer.
Shares
When shares are allocated to an individual, they immediately become a shareholder of the business and gain equity ownership. Alongside partial ownership in the business, the individual is awarded shareholder rights including voting rights, access to dividends, and the right to a share of company assets if the business is sold or dissolved.
How are shares allocated?
For small businesses, shares are typically issued a nominal value – for example, 1p or £1 per share. They are then offered to potential shareholders (e.g. investors or employees) who will pay upfront for their shares, making ownership effective immediately.
If the distribution of shares is part of a funding round or angel investment, a premium may be added to the nominal value of shares which with paid by the investor or investors.
Reverse Vesting and Business Protection
The reason many businesses opt to issue shares is centred around the idea of vesting. Vesting is a mechanism whereby shares are earnt over a duration of time and are only totally allocated once an allotted segment of time has passed.
Shares are typically reverse vested, whereby shares are given to the shareholder immediately. However, if the shareholder leaves the company before the set period of time, they are legally obliged to sell the unvested shares back to the company – usually for no profit.
Essentially, reverse vesting can act as protection for shareholders in the business, as it can aid in avoiding scenarios whereby a significant shareholder leaves the company taking a significant stake of the business with them as they go.
Options
Like shares, options can be granted to an individual or groups of individuals. The key difference is that options do not immediately grant the holder any shareholder rights, instead they award the holder the rights to convert options into shares at a future date and at a pre-determined price. This is popular amongst FTSE 100 companies who commonly offer share options to new employees.
Converting options into shares are typically subject to pre-agreed conditions, for example duration with the company or the manner of which an employee exits from the business.
How are options allocated and converted?
Unlike shares, granting options avoids any upfront payment from the holder or the business. Options are instead converted into shares when the shareholder activates their option and pays the pre-agreed fee per share, commonly referred to as the ‘Strike Price’.
The strike price will commonly be close to or totally aligned to a fair reflection of the market value investors paid during the previous funding round.
Keeping your employees engaged using Forward Vesting
Share options and forward vesting are mechanisms utilised globally to ensure top talent inside your business remains engaged and motivated to return growth and success.
Forward vesting differs from reverse vesting as the shareholder is allocated options incrementally over time. For example, a business may award a top performer share options that increase in number over a period of five years.
Typically, forward vesting is engineered to incentivise employees to stay at a business and continue to grow their share value throughout the duration they are with the business.
Simply put, the more options they accrue, the more they can convert into shares down the line. It is important to remember that although no tax is paid when options are granted, the option holder will be liable to pay capital gains tax when the options are exercised.
Shares and Options – Key Differences
Shares and options can sometimes be confusing, and the tax implications are important to consider. The key difference between a share and an option, is that shares are immediately allocated, whereas options are granted, and exercised into shares that are allocated at a future moment in time.
Allocated shares provide immediate shareholder rights, whereas options have no shareholder rights until they are exercised. Both shares and options are excellent tools to drive employee engagement, and mechanisms such as forward and reverse vesting can protect founders and businesses from hostile practices from would be shareholders.
For more information about the differences between shares and options and the key benefit of these functions, get in touch with our team.