In Short
- Share options offer employees the opportunity to buy company shares at a future date.
- They are a tool for attracting and retaining talent.
- Understanding the legal and tax implications is essential before offering share options.
Tips for Businesses
Before offering share options, consult a legal expert to ensure compliance with regulations and understand the tax consequences. Share options can motivate employees, but they must be structured carefully to avoid unexpected legal or financial challenges.
In Australia, various types of companies exist, one being a ‘private company limited by shares’. Each of these companies has ‘share capital’. This implies that individuals, other companies, or trustees of trusts can purchase shares in a specific company and become either full or part owners of that company. Companies can issue different types of ‘securities’, with the two primary ones being ‘shares’ and ‘options’. This article will explore what ‘options’ are and how they provide distinct benefits and rights for your company and employees.
What is an Option?
An option is a type of security where a company grants an entity the right, but not the obligation, to receive a share in the future upon certain conditions being fulfilled. When you receive an option, you become an ‘optionholder’.
There are various strategic and commercial reasons for a company to grant you an option. For example, options can be provided to employees of the business as a performance incentive.
When a company grants you an option, the company does not actually issue the option as it would issue a share.
Options benefit the company as you become a shareholder once you convert your options into shares in the future. As you are not a shareholder, you are not able to vote on shareholder matters or receive dividends.
Options are particularly beneficial to the company when they are given out as part of an employee share option plan, as options are a great incentive tool for employees.
How Does an Option Work in Practice?
When a company’s directors decide to grant an option in the company, you gain the right to receive a share in the company at a future point in time.
For the benefit of the company, options usually come with certain conditions that you must meet before you can convert your options into shares. These conditions include ‘vesting’ conditions and an exercise price.
The first condition you must fulfil is the vesting conditions attached to the options. Once you satisfy the vesting conditions, you can exercise (convert) the options into shares. Then, you will provide the company with an ‘exercise notice’ and must pay the company the ‘exercise price’ attached to the options.
Continue reading this article below the formWhat Are Vesting Conditions?
Vesting conditions typically come with options and are connected to either time or key performance indicators (KPIs), or both. Vesting enables you to earn the options gradually over time.
Time-based Vesting
Time-based vesting means that you cannot turn your options into shares until certain points in time have passed.
For instance, you receive 100 options in a company with a total vesting period of two years. These options vest every six months over those two years. If you receive the options on 1 January 2024, they will vest as follows:
- 1 July 2024: 25 options
- 1 January 2025: 25 options
- 1 July 2025: 25 options
- 1 January 2026: 25 options
On 1 July 2024, you will have 25 vested options, and you can turn those into shares. You’ll be able to do this at each of the remaining time points listed above.
KPI-based Vesting
With KPI-based vesting, you cannot exercise options into shares until you have met a specific KPI or multiple KPIs.
What is the Exercise Price?
The call option deed, which outlines the terms and conditions for options, or an offer letter for an employee share option plan, will specify the number of options and their price. You, as the optionholder, pay this price to the company when you exercise the option, converting it into a share. This price, also known as the ‘exercise price’ or the ‘strike price’, is paid in cash.
What Happens if the Conditions Attached to the Options Are Not Satisfied?
If the vesting conditions are not fulfilled, we handle the options based on whether they are ‘vested’ or ‘unvested’.
The company usually buys back vested options at the current market value per share. Unvested options simply expire without any value.
For instance, an employee share option plan where you receive 100 options over a four-year vesting period, with quarterly vesting across those years. If you leave the company after two years, you will have 50 vested options and 50 unvested options. The unvested options expire, giving you no value for them. The company might buy back the vested options at the current share value.
You, as the option holder, will have a specified time frame to exercise your options. This period is agreed upon by both parties and outlined in the call option deed or offer letter. Depending on your agreement, you may exercise the option once it vests or upon meeting specific conditions (such as achieving pre-agreed performance milestones). Additionally, a condition may be attached where the options can only be exercised upon the sale of the business or listing on the stock exchange.
Other Key Considerations
Before you enter into any call option deed or provide an offer letter, make sure you review your:
- company’s constitution;
- shareholders deed; and
- terms of any existing arrangements.
You need to ensure that you meet any requirements outlined in those agreements.
Typically, there are pre-emptive rights over securities in your company, and you may need to obtain requisite approvals before granting the options.
LegalVision’s Employee Share Schemes Guide is a comprehensive handbook for any startup founder or business owner looking to attract and motivate top employees with an Employee Share Scheme.
Key Takeaways
If you have been given options or have given options to another entity in your company, you need to understand the basic workings of options. It is crucial to grasp how options can benefit you, when they are most useful, and how they operate in real-world scenarios.
If you have any questions about share options or issuing options, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Vesting conditions are typically based on time or performance (KPIs). For time-based vesting, options become exercisable at specific intervals. For KPI-based vesting, options can be exercised once certain performance targets are met.
If vesting conditions are not met, unvested options usually expire without value, while vested options may be bought back by the company at the current market value.
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