How share-based incentives can help small firms in tough times

The concept of vesting is commonly used.   This essentially guarantees options once vesting criteria have been met.  

This could mean that if an employee is disqualified from exercising the option, they can still exercise the vested proportion into shares. 

Ultimately, the way businesses look at remuneration is changing.

Options are also hugely flexible as they can be crafted to maximise the incentive while protecting the business against future events.

That said, it is important to get the documentation right to avoid getting in a pickle. 

For example, if the option is to be exercised only on a sale of the whole then an employer would want to make sure the option holder is required to enter into the sale documentation meaning they cannot hold up or otherwise delay the sale.

If the option holder can exercise earlier than on a sale, then you would want to ensure that the holder enters into a Shareholders Agreement with the other shareholders. 

The consequences of failing to properly consider crucial elements of the document can be catastrophic. 

While it is likely that the holder of an option will be required to pay something for the shares when they do exercise the option, often a cashless exercise mechanism will mean that the holder can set off the proceeds from the sale of shares against the exercise price meaning they don’t need to raise any cash. 

Granting shares

If EMI options are not available, then rather than grant unapproved options it may be preferable to grant actual shares.  This could mean that any gain is taxed on a capital gains basis rather than an income tax basis. 

In this instance, if the shares issued to the holder are done so at a discount to market value, then the discount could be within the income taxes regime.

While this is not preferable, thereafter any increase in value could be taxed on a capital gains basis.  

Unlike EMI options, with unapproved options and growth shares it is not possible to seek approval of market value in advance, so there is a risk that in the future the value set as market value is disputed by HM Revenue & Customs resulting in an unexpected tax liability. 

Clearly it is not ideal for any tax to be payable on the issue of the shares in question, and on that basis anything that can be done to limit the day one value (and thus any tax payable) is important.

Growth shares can be used to limit the value given to the employee on day one by allowing them to share in the increase of the value of the shares.