UK Employee Stock Option Plans - The Basics

For first time entrepreneurs, there's a million things to think about. At some point, the question of stock option plans will come up. There's a war for the best talent, especially in London. Having a tax efficient stock option scheme is one of the few weapons that startups have in that war.

After working as COO in a few UK startups, I've learnt a few things along the way. Here's a few basics to get you started.

Please note - I am NOT an expert. Please take expert advice before acting.

First of all you will need an ESOP (Employee Stock Option Plan) written up and approved by your board. You'll need a good lawyer to draft this. There are specialists.

You'll probably want the ESOP to be under an EMI scheme. (Enterprise Management Incentive). This is good for UK early stage companies because there is no tax burden on recipients of stock option grants when they exercise their options. The only tax burden is on realisation of the gain (at exit) - capital gains tax.

Note that EMI scheme options can only be granted to full-time employees and the earliest possible granting date is the first date of employment. There's a maximum value that can be granted to any individual and there are eligibility criteria for companies to meet.

Before you grant any options you'll need to get a valuation that you use for tax purposes from HMRC. Use a specialist lawyer or your accountant to make this application.

Keeping the valuation low maximises gains for employees and therefore extends the impact of your stock option pool. A valuation once agreed usually lasts 90 days before it expires.

For each person you grant options to, you'll need to issue them with copy of the ESOP as well as an option granting agreement (OGA).

The grants need to be registered with HMRC.

The OGA contains the vesting schedule .

  • A typical vesting schedule for a UK venture backed startup would be over 4 years. After the end if year one, 25% of the grant vests (the first tranche), the rest would vest in equal amounts (6.25%) every quarter (the remaining tranches).

  • Alternatively you could vest over 3 years. You could also vest the final tranches monthly instead of quarterly.

With all of the above be sure to keep detailed records of who has been granted options and when together with proper files. If you don't you'll regret it down the line.

It's important to do all of this right first time.

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