Apr 14, 2021 8:48:38 PM
Words by Kartik Krishnan and Scarlett Pierce, imagery by Dave Breckon.
In this article, we’ll cover the full life cycle of an option and explain what’s needed at each stage. A useful guide for any company considering giving employees options for the first time, it’s also intended as a refresher for those looking to overhaul or upgrade their current share scheme.
At Capdesk we want to see every company give employees equity, so our platform is packed with features that make option schemes simpler and faster to manage. In each section, we’ll highlight exactly how Capdesk helps.
First things first, you need to set up an employee share options scheme (ESOP). ESOPs can take many different forms, such as the EMI scheme in the UK. Issuing share options via a scheme means that the options are officially registered with HMRC and eligible for certain tax treatments when it comes to exercising.
Capdesk can’t set up an employee share scheme (ESS) for you, but we have trusted partners who can – such as Mill Consultancy. For a fixed price (discounted for Capdesk customers) Mill Consultancy will design and implement your share scheme. Find out more about EMI schemes in our article with Mill Consultancy MD Jerry Davison, or read about post-EMI schemes including CSOPs, in our resource centre.
Once your plan is set up, you can use Capdesk to reserve the total number of options in your company’s cap table – also known as your option pool.
Now you’ve got a scheme set up and an option pool reserved, it’s time to start issuing equity to your employees. You only get one shot at a first impression, so communicating the value of share options at this stage is crucial. But if you’re issuing options manually, and having them signed and witnessed in-person, the time you’d like to spend educating your employees is often used up on administrative tasks.
In the UK, you’re required to notify HMRC of any new EMI options within 92 days of granting them. If you miss this deadline, both the employer and employee are at risk of losing the tax benefits of the EMI scheme.
Instead of issuing your employee all of their options at once, you’ll typically set up a vesting schedule so that options vest gradually over a period of years. If you view options as an employee benefit, this makes sense: the total number of options corresponds to the value you believe the employee will bring to the business. The longer they stay, the more they contribute to the company’s growth, and therefore the more options they are entitled to.
When you give somebody options their monetary value increases in line with your company, so communicating the latest company valuation to employees can act as a powerful incentive. Valuations are commonly needed in fast-growth companies, such as when you set up an EMI scheme, so it makes sense to leverage them for the benefit of your employees.
On Capdesk you can record all company valuations – including average market value, unrestricted market value and 409a valuation – and choose to make the information visible to your employees.
We’ll also notify you via of upcoming valuation expiration dates via the platform, so your company data is kept up-to-date and you don’t become ineligible for any tax benefits.
In order to maintain accurate records, you will need to produce a yearly share-based payment report and submit an annual return to Companies House. Both contain details of employee option grants, because you’re effectively paying your employees in the form of shares.
At the point at which an employee leaves your business, they have a choice: relinquish the options or convert them into actual shares – commonly known as ‘exercising’. Exercising options involves selling them to the employee at the pre-agreed strike price, which is the cost per share specified at the point they were issued. Managing this process manually can become very time-consuming, especially with a large workforce.
With Capdesk you can manage the entire process of exercising options online, including payment. We’re partnered with Shieldpay, which holds fees in an escrow account during the transaction.
If an employee is classed as a ‘bad leaver’, Capdesk handles the termination of options and automatically updates your cap table accordingly.
If an employee leaves before their vesting schedule is complete, their unvested shares must be accounted for and returned to the option pool. This prevents you from unnecessarily increasing the option pool and diluting existing shareholders’ holdings.
Liquidity is what happens when you’ve exercised your options, received shares, and then sold those shares on in exchange for cash. It’s the end goal for every employee option-holder, and turns theoretical value into actual tangible wealth. The problem is, it’s not very common.
Historically, employees have had to wait until a merge, acquisition or IPO to convert their shares into cash. These events are rare, complicated and often costly for all parties, so Capdesk provides an alternative: secondaries.