Options for
Sharing Success
Suzannah Crookes
16 November 2011
#bootlaw
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Reward
Incenti SHARE
vise INCENTIVES Retain
Motiva
te
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Shares v Options
• Issue shares now
– pay upfront
– become shareholder
• Grant rights to acquire shares
– nothing to pay now
– no shareholder rights
• Key commercial factors
• Tax treatment
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What might a share option look like?
• What do you get?
– number of shares
– may be subject to time vesting or performance conditions
• How much will it cost – i.e., exercise price?
– if market value, then delivers growth in value on exercise
– alternatively could be “nil-cost”, to deliver whole share value
• When do you get the shares?
– often exit-based – sale, business sale or IPO
– could have specified time period after which can exercise
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Time Vesting
• Option shares vest over time
– Annual, quarterly, monthly
• Exit-based plan
– Could apply on exit so entitled to only what has
vested (subject to discretion to accelerate); or
– Automatic acceleration on exit
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Performance Target
• Option only exercisable to extent performance
targets are met
• Targets could look at a whole range of factors –
including financial and non-financial
– how are you trying to motivate?
– do you want additional reward for exceptional
achievements?
• Exit-based plan might have target for certain levels
of exit proceeds/price per share on exit
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Leavers
• What happens?
– “if you leave you lose”; or
– retain option in specified “good leaver”
circumstances; or
– subject to Board discretion?
• Get to keep all shares/vested shares?
• Wait until exit/accelerate for “good leavers”?
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Corporate Issues
• Board approvals
• Authority to issue shares
• Pre-emption rights
• Employee shareholders pre-exit
– Separate class of share?
– Leavers?
• Investor consents?
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How does the tax work?
Employee or director (including NED, where appropriate)
• value delivered on acquisition is employment income,
subject to income tax
– collected under PAYE if there is a market in the shares
(e.g. on an exit)
– if PAYE, national insurance contributions also due
– employer and employee can agree in relation to share
options that the employee will bear the employer NI cost
• after acquisition, growth taxed (normally) as capital
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Reminder of Current Tax Rates
Income Tax
• Up to £35,000 Basic Rate 20%
• £35,001 - £150,000 Higher Rate 40%
• Over £150,000 Additional Rate 50%
Capital Gains Tax
• 18% for up to Basic Rate threshold
• 28% above that
• Annual allowance - £10,600
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Issue Shares now
Pay £10 on acquisition of 100 shares at 10p each
50p CGT on £40 gain on sale @ 28% = £11.20
40p
30p
Assume whole
gain taxed as
20p capital
10p
1 2 3
Years
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Grant Options
On exercise, pay £10 aggregate exercise price
50p Income tax on £40 gain @ 50% + 2% NICs = £20.80
40p
30p
20p Income
10p
1 2 3
Years
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Illustration
Issue Shares upfront Options to acquire shares on Exit
Now
Individual pays market value per share Nothing to pay on grant of option and no
OR acquires shares for less, but pays tax consequences.
income tax on discount.
Individual has no voting or dividend
Individual has upfront cost and takes risk rights.
that share value falls, but is a
shareholder with voting and dividend
rights.
Exit (sale or takover) after three years
Shares sold on exit - growth in value is Options exercised on exit and shares
subject to capital gains tax at 28% (18% then sold. Individual pays option exercise
if basic rate) price – value above that subject to
income tax at up to 50% plus NICs
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Enterprise Management Incentives
EMI
• Share options which meet certain conditions
• Generous tax advantages
• Smaller “trading” companies
• Intended to assist recruitment and retention
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EMI Qualifying Conditions
EMI Company EMI Optionholder
Independent Employee or executive director
Gross assets no more than £30 million Fulfills “working time requirement”:
Fewer than 250 employees • 25 hours per week; or
• 75% working time
Qualifying trade No “material interest” – 30% shares
Overall limit on value of shares under Individual limit - £120,000
EMI options - £3 million
Disqualifying events – loss of beneficial tax treatment going forward
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EMI Options
On exercise, pay £10 aggregate exercise price (mv at grant)
50p No income on exercise – CGT if sold immediately = £11.20
40p
30p
20p Capital
10p
1 2 3
Years
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Example
• Company worth £500k
• Options over 10% - exercise price £50k
• Options exercised when company value is £1 million
• Value received (£100k) less exercise price = £50k
• Option shares sold immediately
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Example (cont)
What is the tax cost?
Unapproved Options
• 50% income tax on exercise + 2% NICs = £26,000
EMI Options
• 28% capital gains tax on sale of shares, if annual
allowance available = 28% x (£50,000 - £10,600) =
£11,032
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EMI at a discount
50p
40p
Capital
30p
20p
Income
10p
1 2 3
Years
19
EMI Disqualifying Event
50p X
40p Income
X
30p
20p Capital
10p
1 2 3
Years
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Shares for non-employees
Tax
• Non-executive directors – taxed in same way as
other directors and employees
• Consultants and advisors – income tax assessed as
profits of the trade
• NB – employment status
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Shares for non-employees
Corporate Issues
• Additional corporate issues arise:
– No automatic disapplication of statutory pre-emption
rights
– Not an “employees share plan”, so make sure other
relevant exemptions apply from the restrictions under
the Financial Services and Markets Act 2000
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Other tax things to think about
• Entrepreneur‟s relief
– Reduce CGT on disposal to 10% on first £10M
– Conditions – includes 5% shareholding for at least 12
months
• EIS relief
– Complex conditions – changes due in April 2012
– Income tax relief (30%) on investment up to £500k pa
– CGT exemption on disposal
– CGT deferral on reinvestment
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More in the pipeline
Government consultation
• Improvement and simplification of existing EIS and VCT
schemes
• Additional support for seed investment through a new
“Business Angel Seed Investment Scheme” (BASIS)
– Recognises current undersupply of risk capital to
high-tech and innovative businesses
– Link to requirement for business advice and expertise
for companies at pre-start-up or “seed” phase
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These slides do not constitute legal
advice.
Specific legal advice should be taken on
any of the topics covered.
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