Shares vs. Options: What's the Difference? | SeedLegals

Ordinary option

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Options Schemes Oct 22, 7 min read Shares vs. Jonathan Prezman Most UK startups offer equity compensation to employees in the form of options by setting up an EMI employee option scheme.

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Here at SeedLegals, we often get asked what the difference is between shares and options. If someone owns options, have own the right to buy shares in future. The differences fall into 4 main categories: Ownership of the company Cash payment for the equity Vesting and protection Tax implications 1.

Ownership in the company Whilst shares give the shareholder immediate ownership in the company, ordinary option are a little more complicated. They allow the individual to become a shareholder at some point in the future, once the options have converted into shares.

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Example: Dan gets issued and allocated 1, Ordinary Shares that carry one vote per share and the right to dividends. The company has a share capital of a total of 99, Ordinary Shares. The conversion of the options are subject to many conditions, which may never be met.

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In practice, the options holder will usually exercise their options on exit, since they are liable to pay for them, and would only typically do so when they know they will be sold directly after — such as at an exit. Example: Dan is granted with 1, options, and after 3-years, they have the right to exercise his options and convert them into 1, Ordinary Shares that carry one vote per share and the right to dividends.

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After 3 years, once Dan decides to convert his options into shares, they will become a shareholder. Cash payment Another important difference between the two forms of equity compensation is the method of purchasing the shares. This has a wide impact on both the individual and the company, and from our experience, this is not always taken into consideration.

To avoid future hiccups down the line, we recommend that you think about this carefully when choosing which form of equity compensation to use.

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  • Most of the debate is over whether options should be counted as an expense, which would reduce reported earnings and possibly undermine share prices.
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Shares Once shares are issued and allocated, the shareholder owns them. In those cases, there may be some major tax considerations more on this below. Whilst a vesting period can be set for both shares and options, in the UK there are two ordinary option methods in which options vest vs.

Employee stock options ESOs are a type of equity compensation granted by companies to their employees and executives. Rather than granting shares of stock directly, the company gives derivative options on the stock instead.

Shares Reverse vesting: shares are issued and allocated to the shareholder upfront, but the vesting mechanism works reversely. So, if the shareholder leaves the company before the end of the vesting period, they will be forced to sell the unvested shares usually at no profit to the company.

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This is a form of protection for the company, and helps to avoid a situation where a shareholder suddenly leaves the company and takes a large stake with him which is why companies almost always have founder vesting in place. In startups this is really important, as a shareholder that leaves the company with a big portion of equity may make the company uninvestable in the future, since very little equity would be left for future investors.

Shares vs. Options: What’s the difference?

Example: Dan gets issued and allocated 1, Ordinary Shares with reverse vesting on a 4-year period. After 1 year, Dan leaves.

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Because a reverse vesting mechanism was in place, the company has the right to repurchase the shares that were yet to vest. Options Forward vesting: the vesting mechanism for options is forward vesting, whereby the options holder is granted with options incrementally, usually over a years period.

This will incentivise the ordinary option holder to stay with the company and will keep motivation high.

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The longer the option holder stays with the company, the more options they will get and the more options they will be able to convert into shares in the future. They can be used as a great tool to compensate a low salary, and they be often a carrot that keeps key employees on board.

Example: Dan is granted 1, options vesting over a 4-year period. After ordinary option year, Dan leaves the company, with only options vested and the remaining options unvested.

Tax implications and tax benefits of an employee option scheme Binary options video last point to note is the tax implications and ordinary option.

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Whilst this may seem very complex, the principles of the tax strategies are quite easy to understand. We have simplified it as far as possible but tax treatment is subject to change and individual circumstances, so if in doubt do consult a tax advisor for bespoke advice or contact SeedLegals.

Employee Stock Option (ESO)

Shares Generally speaking, issuing and allocating shares to an individual at a discount will result in an immediate tax charge for the employee and employer.

In order to value the shares, HMRC will use the price paid per share by investors in the last funding round or the trading history of the company to find out the earning per share. Options No tax is paid by either the option holder or the company when options are granted and even vestedbut….

As you can imagine, the actual market value of the shares may be very high at the time of ordinary option after a few years. So one of the most obvious questions here is whether there is a way to cap this increase of the market value of the shares? And the answer to that question is: Absolutely. ordinary option

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This is where the EMI employee option scheme comes into play. EMI schemes are tax-advantaged schemes that can be highly beneficial for both the company and the individual option holder. The company pays no tax on the options at all.