It’s easy to get confused by the difference between share options and giving shares to employees. This article looks at the key differences to help you decide between share or stock options vs shares. Plus whether you should set up a share option scheme for your company.
What are share options and stock options?
Firstly share options and stock options mean the same thing. Share options are more likely to be used in the UK, and stock options are more common in the US.
Share options are a way of saying to staff, “When the company gets bigger, in a few years time, you can have the option of buying some shares at a price we agree now. That price will usually be cheaper than if you buy the shares at the time.”
It’s a bit like saying that you can buy a loaf of bread in Waitrose in 5 years time at what it costs today. Given that the bread, and the shares, is likely to be more expensive in 5 years time, this can be a bargain for staff in the future.
If this is all new to you, then this article explains a lot more about share options and giving shares to staff and investors. If you’re just here to talk about whether you should offer options or shares, read on.
Why would you have a company share option scheme?
Share options schemes are used by bigger companies (or companies which are planning to get bigger because they’ve got some investment or are growing fast) as a way of incentivising staff. You offer someone the option to buy the shares later at a discount because you want them to stick around. If you just gave them the straightforward choice of buying some shares in the company now, they might buy the shares and then leave. Which you probably don’t want your staff to do.
Not only do you want them to stay with the company, but you also want them to work hard and make a big contribution. Giving someone shares in the company, or the chance of buying shares at a discounted price later makes them feel like they’re part of the family, that if they work hard, they’ll benefit as the company grows.
What are the advantages and disadvantages of share option schemes?
That depends. If you’re a little company, say three or four people and you’d maybe like to grow to about a dozen people, then a company share option scheme might not be the right choice for you.
That’s because it takes quite a bit of setting up, and legal and accountancy fees. You might want to think about the Enterprise Management Incentive share options as an easier way to do this if you’re still tempted, as the EMI scheme is simpler to set up. Or you might just want to give some shares to staff – see below for some alternatives to share options.
Where a company share option plan is a good idea
If you have big plans, maybe some investment already and a team of people who you want to give shares to, a share option plan or the EMI share options way of issuing shares could be good for you. But your plans will need to be pretty big to make it worthwhile for staff.
Although a company share option scheme lets you offer your staff the option to buy shares later at a beneficial price, you have to think about whether they’ll want to, and if this offer is truly to their advantage. It sounds good. But it can be one of those things you read about in a business book about fast-growing US tech companies and assume that it’s what your company should do. That’s certainly the position I was in a few years ago when I was working in a tech company, and I thought that we should have a company share option scheme because that’s what Google type companies do.
Learn from my experience at a tech company
If you’re building a company where you’re hiring new staff every month, doubling turnover ever six months, and growing fast, you still might only want to offer shares to some key members of staff. Here’s why we didn’t set up a company stock option scheme then.
- It would have cost a whole lot of money for lawyers which we would rather have spent on developing the company. We paid for a new programmer for a year with the legal fees we saved
- It would have taken up quite a bit of my time as Operations Director when I should have been working on building the business
- It didn’t offer any real benefit to staff, as although we were growing fast, we didn’t know if we’d ever become big enough for a floatation.
The last of these is the big one for staff.
Can staff sell their shares later?
If you give staff stock options, these are only attractive if they can sell their shares later and make a sweet bundle of cash. This is the bit that you hear about people who worked for Google or one of the big tech companies which have floated on the stock exchange, and they got stock options. These particular staff members would then be able to sell their shares on the open market years later because they had shares in a public company.
It’s only when your company floats on, say, AIM in the UK, that people can publicly sell their shares on the open market to anyone who wants to buy them. If your company is likely (or you want to) remain in private hands, your staff will only be able to sell their shares to you (the owner) or the company. In fact, you’ll have written this into their shareholder’s agreement. And if you don’t have the cash to buy them, or you don’t want to, the shares are worthless until you sell the company.
What about when you sell the company?
I often work with business owners who are aiming to grow their company to sell it in 5 or 10 years time. Having a share option scheme can be a little bit of a complication when you come to sell because you’re not selling the whole company outright. But having staff with share options or additional shareholders wouldn’t stop anyone buying your company if they wanted it, as long as all the paperwork is done correctly.
Advantages and disadvantages of a share option scheme vs shares
Here’s a summing up of the advantages and disadvantages of share options vs shares
Advantages of share options vs shares
- People feel that they’re part of an exciting growing business
- You’ll get a cash injection when people exercise their share options and buy their shares, although that might not be for a few years
- It will incentivise staff and make them feel part of the team
- It will encourage key people to stick around, so it’s great when you’re competing for talent (although remember that eventually, they might leave once their options are due to vest)
Disadvantages of shares options vs shares
- It’s a lot of work to think all of this through and work with the lawyers
- Legal fees take money out of the business
- If the business doesn’t end up floating, the shares may be effectively worthless to the staff, unless you sell the company
Advantages of giving shares vs share options
- Just issuing shares to staff is much simpler and easier to set up, although you still want to protect yourself and get advice. Remember to read this article about giving shares
- Giving shares is a lot easier to explain to staff than explaining options, which employees may see as esoteric and unreal
Disadvantages of giving shares vs share options
- If your company is already making a decent profit, make sure that you don’t create a tax liability for your staff by giving them shares. Think about growth shares, or the EMI scheme instead if this might be the case for you.
- Make sure that you protect yourself and your company if anything happens to your employee or if they leave. You’ll need a shareholders agreement. More details of how to give shares while protecting yourself here…
If you need some help with shares in your business
I do quite a lot of work in this area, so if you’d like to talk about what’s the best option (excuse the pun) for your business, think about booking one of my business decision-making sessions. It could save you hours of thinking about this, and thousands in legal fees.
Other helpful articles about how to give shares to others
You might want to also read these articles about shares and equity: