Share and Stock Options

Many senior executives now receive shares or stock options as part of an incentive package to assist in the retention of senior staff. They are an attractive 'low cost' employee benefit.

What is an employee share option? 

An employee share option is the right to acquire shares in a company (usually the employing company) at a pre-set price referred to as the 'exercise price'.

Typically, the exercise price is the market value of the shares at the time the option is granted; sometimes, the exercise price is below or above the market value at that time. An opportunity to acquire shares for no cost is referred to as a nil-cost option and may form a non-cash element of executive remuneration.

What is an employee share option scheme?

Companies often grant options using a scheme or plan containing the contractual terms of the options in a set of sometimes complex rules. The rules cover key features of the options.  

Employee share options can be very valuable; if the share price rises above the exercise price, the employee can profit by exercising their option to sell the shares. In essence, a share option means that an employee can buy a share for less than it is worth at the time of exercise. (i.e. at a discounted price.)

Frequently, executives don't pay anything (directly) for a share option and will only incur any costs if they decide to exercise the option. Employees do not have to exercise their options if the share price falls. As a result, in these circumstances, the employee will not make any profit from the options but will not lose any money either, so there is no risk.

Typical features of share options

The terms of employee share options are broad, but most convey some basic standard features.

Employees must usually wait a period of time before exercising share options. That is part of the retention objective. A share option may be exercisable at any time after the grant date, but usually, employees must wait before being able to do so.

Options may also become exercisable after a set period of time expires, such as three years, or sometimes options may become exercisable only if a particular event occurs. (i.e. if there is a business sale or listing of the company).

Good leaver provisions

Most share option schemes will provide for what happens when someone leaves employment. Typically, employee share options will lapse unless an employee leaves due to ill health or redundancy. However, share option terms often allow an option to be exercised early for 'good leavers' or enable the executive to retain part of the option until the exercise date.

Lapse provisions

Options usually lapse on certain events, which may include:

• Resignation to take up employment elsewhere unless a 'good leaver'
• The employee does not exercise the option within a time limit specified in the terms of the option
• The employee is made bankrupt

Company events

Most share option schemes will include details of what happens to options when certain corporate events occur, such as a takeover. 

Schemes may include provisions that:

• Permit option holders to exercise their options immediately before or for a period after a corporate event
• Allow option holders to exchange their options for options in an acquiring company if the acquiring company offers this facility

Reasons for granting share options

There are many reasons an employer might want to grant share options to employees.

All types of share incentives, including share options, can help align the interests of employees with shareholders. They help ensure that employees are interested in increasing the value of the company's shares or getting the company to a sale or flotation.

Share options lost when an individual leaves employment can aid retention while offering share options can help recruitment.

Also, if tax-advantaged share options are used, the employer will not have to pay employer NICs on options gains, even if the shares are readily convertible assets, so using share options can reduce employment costs (see Taxation of share options).

Companies which do not have the cash available to pay larger salaries can use options to reimburse employees in the longer term.

Funding the exercise price

An employee needs to be able to pay the exercise price upon exercise of the option. How the exercise price is funded varies from scheme to scheme. In an SAYE option scheme, employees make monthly savings, which they use to pay the exercise price when exercising the option. In some schemes, the employee must fund the exercise price out of their own resources. Sometimes, the employee can sell some of the shares to pay for the exercise of the option (cashless exercise).

Key terms used in relation to share options

Several terms are commonly used when describing share options or drafting share option documents. These include:

Cancellation/release/surrender - An employee agrees to give up the share option upon cancellation, release or surrender. Sometimes, an option will be released for consideration (usually a payment), and sometimes, an option will be released for no or little consideration.

Discounted option - An option that gives an employee the right to acquire shares at a future date for a price that is less than the market value of the shares on the date on which the option is granted. This is different to a nil-cost option, of course.

Exercise - An employee who exercises an option calls on the grantor (usually the company) to fulfil its obligation to issue or procure the transfer of shares to the employee.

Good and bad leaver provisions - Many option arrangements include provisions determining what happens if an employee leaves employment. Most will differentiate between "good" leavers (such as an employee who is injured or made redundant) and "bad" leavers (such as an employee who is dismissed or who resigns). These are known as good and bad leaver provisions.

Grant - This is the award of a share option to an employee.

Lapse - When an option lapses, in broad terms, it ceases to exist. It can no longer be exercised, and the employee can no longer receive any benefit.

Market value option - An option which gives the employee the right to acquire shares at a future date for the market value of shares on the date the option is granted.

Nil-cost option - An option which gives the employee the right to acquire shares for no cost.​

Vest - UK practitioners generally use this term for the date an option or award becomes unconditionally exercisable or the shares become unconditionally deliverable.  

Get in touch

For more information and guidance on Employee Share Options, please contact our Employment Litigation Team on 023 8063 9311 or email enquiries@warnergoodman.co.uk.