Understanding the key terms, tax liabilities, and your My Equity page.
First of all, congratulations! You’ve been granted equity in a company.
Depending on the future growth of the company, your equity could turn into a life-changing sum. Plus it shows the company values your hard work.
But you’re probably wondering, what does all this mean? Here we’ll explain the top 5 things you need to know about your options.
1. Your option agreement
This is the contract between you and the company that has granted you the options. It contains all the legal details and outlines what you need to do to ‘earn’ your options, such as your time or performance-based conditions, vesting schedule, exercise price and exercise conditions (more on all this later).
When you get familiar with the key terms we’re talking about here, your option agreement will be your go-to for any questions you may have.
2. Key terms
As we alluded to above, there are quite a few terms surrounding options that you may or may not be familiar with. So let’s get into what they all mean.
Options are a type of conditional equity. You have been granted the ‘option’ to purchase shares in the company, so long as you fulfil the conditions in your option agreement, both in terms of when they vest and when they can be exercised.
Vesting is how you ‘earn’ your options. As you fulfil the conditions of the option agreement (these can be time or performance-based conditions) your options vest and become yours to keep. How your options vest will be determined by your vesting schedule…
Your vesting schedule is the timeline over which your options vest. For example:
- The options vest over a 4-year period, with 25% vesting each year.
- The options vest over a 1-year period, with 25% of options vesting each quarter IF quarterly revenue targets are hit.
Every time a set of options vest is called a tranche. These tranches can be monthly, quarterly, yearly, or based on key performance milestones.
Your vesting schedule may contain a cliff, which is essentially a waiting period from when you accept the option agreement to when the first tranche of options vest. For example, a 4-year vesting period with a 1-year cliff.
3. Exercising
Don’t worry, you won’t be asked to do 100 squat jumps in return for equity.
Exercising is the process of converting the options into real shares. You are exercising your ‘option’ to buy the shares.
When your options vest, they may or may not become immediately exercisable.
Your option agreement will contain the exercise condition. This will either be:
Exercisable: Great news, you can exercise your options as and when they vest. Whether that’s per tranche or all together at the end of your vesting schedule, it’s up to you!
Exit only: Your vested options only become exercisable when the business goes through an exit event. This can either be a sale, merger, management buyout, company buyback or IPO.
Now you may be thinking “there aren't any plans to sell the company, I’ll never be able to exercise my options!” Fret not, as it’s likely the company has set it to ‘Exit only’ for a reason – and while they may not be thinking of selling now, a lot can change in a few years' time.
And when the time comes, you’ll need to pay the exercise price.
Exercise price
This is the pre-determined price per share you’ll need to pay to exercise each option.
The idea being that over the course of your vesting schedule, you’ve helped the company grow, which has increased the company’s share price.
But rather than having to pay the current share price to become a shareholder, you pay the exercise price based on the company value when you first accepted the option agreement.
For example, your exercise price is £0.10p per share. 4 years later, once all your options have vested, the company is worth £1 per share. You will only pay £0.10p per share for shares that are actually worth £1! Talk about a good deal.
But what if the share price goes down? Fair question, and it’s entirely possible that things don’t quite work out.
Luckily, you have the ‘option’ – not the ‘obligation’ – to exercise. So you don’t have to if you don’t want to.
Once you exercise you will become a shareholder, and then it’s up to you whether you sell (if you can find a willing buyer) or hold onto the shares.
4. Tax
Unapproved options aren’t the most tax-efficient form of equity, but they are probably the most flexible.
With that in mind, different tax liabilities are created based on the relationship between the company granting the option and the option holder (you). Tax liabilities vary when you exercise options too, depending on the exercise price and Actual Market Value/Unrestricted Market Value (AMV/UMV) of the shares, at the time of exercise.
This may sound confusing, but it becomes clearer when you break it down into the lifecycle of the option. In this example we’re assuming you’re employed by the company:
- You’re granted the option: no tax is due
- You exercise your options: tax liability is created on the difference between the exercise price and the AMV or UMV at the point of exercise (you can choose whether to set the tax point at AMV or UMV)
- You sell the shares: Capital Gains Tax (and potentially Income Tax) may be due on share sale profits. Of course, you have your annual CGT allowance to use up before any tax is due.
Please note the above is a very brief overview. We go into much more detail about options and tax here, including scenarios for non-employees and companies.
5. My Equity
Now all the legal stuff is out of the way, let’s talk about your My Equity page.
In the past, share schemes like yours were just long, boring contracts nobody understood.
But Vestd works with thousands of companies to digitise their share schemes and help recipients like yourself understand the real value of their equity.
My Equity contains all the information we’ve explained above and presents it in a dynamic graph with current and future potential profit calculations.
There’s also a dynamic tax calculator that works out your tax liabilities and potential profit based on the information in the graph above and the type of equity you hold.
To learn more about your My Equity page, we go into great detail about its features here.
Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'