Valuing shares can be a tricky issue for high growth startups. Private unquoted companies may not have a significant asset-base or historic earnings to refer to so formulating a valuation may not be a straightforward task. In my previous blog, I discussed the difference between shares and share options. Today, I'll take a look at some of the issues to be considered when fixing a share price for shares or share options for employees, but with more focus on share options.
So, what do you need to consider when arriving at a share price when issuing shares or granting share options to your employees?
If you issue shares or grant options to employee at a share price which is less than the market value at the time, HMRC could potentially question the price on the basis that an employee has received a benefit in connection with their employment for less than its value. This could in turn lead to adverse tax consequences for both the company and the holder of the shares/options. Therefore, it's important to consider these issues with your accountants and advisers so that you can limit the risk when you're proposing to either issue shares or grant options.
From the perspective of the employee receiving the shares/options, the lower the share price, the better as they will get more 'bang for their buck'. Accordingly, the timing of when shares/options are issued can be all important.
For example, it will be easier for a company to issue shares for a low value before it starts generating revenue. If, for instance, a company enters into a contract with a customer or an investor for a significant sum, the value of the company could arguably increase as a result of signing up to that contract. So, if the company is planning to issue shares or grant options at a low price, it would be advisable to do this as early in the company’s life cycle as possible so that a low value can be justified.
The company might, however, have a different view to the employee when it comes to setting an option price. If the market value and option price are particularly low, an option with little or no vesting criteria might offer the employee a level of reward that the directors may not think is justified. Investors will also have a view on what is appropriate and may object to an option price below the price they have paid. The flipside is that the company would be reluctant to grant options around the same time at a price much higher than the price paid by investors.
There is no right or wrong answer and many companies will choose to agree a valuation with HMRC to avoid any unwelcome tax surprises in the future. HMRC are not constrained by the last price paid by any investor any may agree a valuation for ordinary shares to be held by employees, well below the price paid by investors for preference shares. The key point to note is that the company has 60 days in which to grant options the date that HMRC confirms the value.
It is not an exact science and it is important to take professional advice when setting the share price for options. I would recommend that companies discuss such matters with - at the very least - their accountants before formalising any such arrangements.
I know of some individuals who have been left disappointed with the outcome of their options and others who have been delighted. Do you fall into either category? If anyone has any thoughts on this topic, please feel free to shares these in the comments section below.
In a future blog, I will look at the new government proposals regarding “employee shareholder status” and the implications for employees and companies.