Stephen Clark kicks off a new series on employee share ownership with a closer look at the difference between shares and share options.
For start-up, spin-out and entrepreneurial companies, cash is often tight in the early years. You may be able get supporters to work or advise you for little financial reward up to a point, but, no matter how generous they may be, the time will come when all parties feel some reward is appropriate.
How do you do this without splashing the cash? One suggestion might be to give them the opportunity to share in the future value of the company by either (1) issuing them with shares; or (2) granting them share options.
Shares or Shares Options: What’s the Difference?
Shares are often referred to as “equity” as they amount to an ownership stake in a company. Once issued, those shares will be registered in the name of the particular shareholder who acquires them. Shares can be paid for in cash or can be issued in exchange for services provided to the Company.
Take the example of Mick who has carried out £1,000 of web development services for Sticky Fingers Ltd. Mick is willing to convert the value attributed to those services into 100 shares in Sticky Fingers at £10 per share. He will become a shareholder (and holder of equity) as a result. £10 is the established market value of shares at that point (which may be different to the “nominal” or “par” value of the shares).
Share Options, on the other hand, give someone the right, or “option”, to acquire shares at a future date at a pre-determined price, subject to any criteria that may be imposed.
Take the example of Keith who is carrying out web design work for Beggars Banquet Ltd. In exchange he receives an option to acquire 100 shares in Beggars Banquet at a price of £10 per share, subject to the criteria that Keith completes the work. If after the option has been granted to Keith, a third party makes an offer to acquire Beggars Banquet for, say, £50 per share, Keith would be able to “exercise” his option to acquire those 100 shares at £10 each and then immediately sell them to the third party for £50 per share, yielding a £4,000 gain for Keith.
Options can offer flexibility both to entrepreneurial companies and to option holders as:
- the shares do not need to be issued up front and shareholder numbers are kept more manageable; and
- the option holder does not need to find the cash to buy the shares until later.
The key issue of how the option price is established will be covered in a future blog.
What are “vested” options?
It is possible to get creative with Options by imposing criteria or targets before the option holder can exercise his share option. This might include completion of a particular task (such as in Keith’s example above), duration of service or the achievement of certain milestones, such as sales targets. When the criteria have been fulfilled, the Option is often referred to as having “vested” in the option holder. These might also be called performance conditions.
So if Keith decides halfway through his web design task for Beggars Banquet that he wants to move to Fiji to climb palm trees, we wish him well, but his options will not “vest” and he would lose his right to exercise his option to acquire those shares.
In contrast, if the company had issued Keith with the shares before he started the job, those shares would be in his name and it would be harder to claw-back those shares if he left halfway through the job. Provisions regarding claw-back of shares can be included in a company’s articles of association which can kick-in if someone leaves, but it is better to avoid having to rely on such provisions if possible.
Options can take any number of forms, some of which can be quite complex, but this simple example sets out the basics.
In the next blog in this series on employee share ownership, I will look in more detail at the issues that a company needs to consider when fixing an option price.