Why employers offer shares or share options

Common reasons for offering equity

Employers use equity to align employees’ interests with those of the company. Offering a stake in the business can help motivate staff, particularly where the business is in its early stages or is targeting rapid growth (where it may not be able to offer salaries competitive with those offered by bigger, more established, businesses).

Start-ups vs established companies: different approaches

Start-ups often have limited cash reserves and use equity as part of their compensation packages.

In contrast, larger or publicly listed companies may use formal share schemes to retain high-performing employees or senior executives.

Incentivising and retaining key staff

Equity can be used to encourage loyalty, often with vesting periods that require employees to stay for a minimum term to benefit. Share incentives are also common in sales-driven or entrepreneurial environments where employees directly influence company performance.

How share schemes work in practice

Types of employee share schemes

There are various schemes, each with different rules, tax treatment, and legal structures:

• Enterprise Management Incentives (EMI): A popular, tax-advantaged scheme for smaller companies, offering favourable tax treatment if conditions are met.
• Company Share Option Plans (CSOP): Approved schemes that can be used by larger companies, though with less generous tax treatment than EMI.
• Share Incentive Plans (SIP): Allow companies to offer free, matching, or partnership shares to employees, often on more favourable tax terms.

Vesting schedules and conditions

Most share or option grants are subject to a vesting schedule, typically over three to four years, sometimes with a “cliff” (no vesting until after the first year). Vesting may also be linked to performance conditions or milestone achievements. Employees should carefully consult their share option agreements and/or grants for details of the vesting schedule and conditions.

Exit events and their impact on shares

Equity agreements often (but not always) include provisions that accelerate vesting upon an “exit event” such as a company sale. In these scenarios, unvested options may partially or fully vest, subject to the terms of the agreement.

Legal rights and risks for employees

Do employees have automatic rights to shares or options?

There is no automatic entitlement to equity unless contractually agreed. Any rights to shares or options must be explicitly set out in employment contracts, option agreements, or shareholder agreements, and employees should ensure that any agreement to equity is set out in writing in an appropriate document – a failure to do so may weaken, or eliminate, the employee’s right to receive the relevant equity.

Restrictions and forfeiture clauses

Employee shares and options often come with restrictions. For example, shares may be subject to compulsory transfer provisions on leaving employment. Option schemes may include forfeiture clauses if the employee leaves before vesting or under certain circumstances (e.g. for gross misconduct).

Good leaver vs bad leaver provisions

Equity schemes often distinguish between “good leavers” and “bad leavers.” A good leaver (e.g. redundancy, retirement) may retain some or all equity rights, whereas a bad leaver (e.g. dismissal for cause) typically forfeits them. The definitions are usually set out in the share plan rules or employment contract, and should be carefully consulted.

Shares and share options in settlement agreements

Can shares or options be included in a settlement?

When employment ends, shares or options can become a key issue during exit negotiations. A settlement agreement may address whether the employee retains equity, receives compensation in lieu, or agrees to waive rights to shares or options. Employers are generally, although not always, keen to ensure that the terms of the relevant equity agreement are complied with, and may not be willing to vary such to encourage settlement.

Valuing equity on termination

Valuing shares or unexercised options can be complex. For private companies, the value may be uncertain without a recent funding round or sale. Settlement discussions may require an independent valuation or a negotiated figure based on estimated company value – this can potentially be a point of dispute, depending on how reasonable the company is willing to be in terms of the identity of the third party providing the valuation and what the company is willing to offer.

Waiving rights to shares or options

Settlement agreements often include waiver clauses. Employees should check carefully whether these waivers cover existing or future rights to equity. In some cases, employees may be asked to sign a deed of release confirming they will not exercise any remaining options.

Tax implications of shares and options

Income tax and National Insurance considerations

When options are exercised, or shares are acquired, the employee may be liable for income tax and National Insurance on any gain between the exercise price and the market value of the shares, unless a tax-advantaged scheme (such as EMI) applies.

Capital gains tax on disposal

If the employee later sells their shares at a profit, they may incur capital gains tax (CGT). The availability of CGT reliefs, such as Business Asset Disposal Relief, will depend on factors such as how long the shares were held and the nature of the scheme.

Tax relief under EMI and other approved schemes

Approved schemes like EMI offer favourable tax treatment if certain conditions are met. Employees may only pay CGT on sale, with no income tax at the point of exercise. It is important to understand the qualifying criteria and ensure proper documentation is in place.

What to consider before accepting shares or options

Reviewing share scheme documentation

Employees should carefully review any share plan rules, option agreements, or shareholder agreements before accepting an offer. Key points to understand include vesting terms, exit provisions, and potential restrictions on sale or transfer.

Understanding dilution and company valuation

Holding a percentage of equity can be misleading without knowing the total number of shares in issue. Future funding rounds or share issues may dilute an employee’s holding. Understanding how company valuation is determined (and whether options are priced above current market value) is essential.

Seeking independent legal advice

Before accepting or waiving share-related rights—particularly in a settlement agreement—it is advisable to seek independent legal advice. Equity agreements can contain complex terms, and the financial and tax consequences may not be immediately apparent.

Shares and share options can form a valuable part of an employee’s total remuneration, particularly in growth-driven sectors. However, these arrangements involve significant legal and tax considerations. Employees should ensure they understand their rights, the terms of any equity offer, and the implications in the event of termination or dispute. Where necessary, legal advice should be sought to protect their interests.