Unapproved options

Frequently asked questions

• What is an unapproved share option scheme?

  Unapproved share options are flexible and can be given to employees, contractors, advisors, consultants and international employees. These options don’t require any formal valuation or notification to HMRC when the options are set up (unlike EMI), although they do need to be included in an annual report to HMRC if they have been given to UK employees or directors.

  There is however no tax benefit for the recipient, who is liable for Income Tax on the difference between the exercise price and the market value of the shares at the time they are exercised.

  An employee may also be liable to pay National Insurance on this sum if the unapproved shares are readily convertible to cash at the point of exercise (in a sale scenario, for example). International employees will be subject to tax in their tax authority. 

  For UK recipients who aren't employees, there is also a potential tax liability on grant of option (VAT) to the extent that the exercise price is below the market value at date of grant.

• What are the main advantages of unapproved share options?

  • Unapproved share options can be awarded to consultants, freelancers, non-executive directors, international employees and others who are not eligible for HMRC approved options (EMI).
  • There are no limits to the number of options that can be given in total or to an individual.
  • You can set conditions for recipients, such as achieving milestones or staying with the company for an agreed period of time.
  • Unapproved share options can be granted to UK employees or directors below market value, with no immediate tax liability.
  • ERS benefits to awarding company: if granting options to employees or directors, the awarding company can offset the cost of the scheme against corporation tax and offset the gain the employee makes on exercise against corporation tax as a relief.

• What are the main disadvantages of unapproved options?

  • Recipients have to pay Income Tax based on the value of the unapproved shares (less what they pay for them) when they exercise them.
  • There is no Business Asset Disposal Relief (BADR), so the normal rate of Capital Gains Tax will need to be paid once sold.

• Do I need to get a valuation done before distributing unapproved options?

  Whilst there is no approved valuation for unapproved share options, it can be useful to get a valuation for a number of reasons.

  1. Employees or directors: employees or directors can be granted options below market value with no tax consequence, so you don't need to know the value of your company at grant. However, you do have to submit the value of your business at the point of grant during your annual notification.

  2. For UK non-employees or companies: there is a potential VAT tax liability if options are granted below market value, so the valuation becomes important to inform the recipients of any potential tax liability.

  3. For international employees: in some countries, there is a tax liability for options on grant, so again, it may be useful to know the tax point for your international recipients (in the US, for example, it is important to get a Section 409A valuation, as the grant of options does potentially create a tax liability).

• When does the recipient pay tax?

  For UK employees or directors, in cases where these unapproved shares are not readily convertible into cash, only income tax (and not NI) is due and declared in the recipient's self-assessment tax return for the tax year in which the option is exercised.

  For non-employees who have been issued options below market value, there will be an additional VAT to pay on the difference between the exercise price and the market value at award and then income tax or corporation tax on the gain at exercise. For international recipients, it will be determined by their local tax authority.

  Learn more.

• What exercise price should be set for the unapproved options?

  This can be any price but typically a price you and the recipient would feel is fair given the current status of the business. Or a lower price if you want to pass the maximum amount of value to the recipient. This is a commercial decision for the business and will depend on specific circumstances (speak to one of our share scheme specialists about this).

• Can I give unapproved options at a £0 price?

  Almost, you could give shares to someone at today’s nominal value which could be an extremely low value. That would mean they pay you next to nothing for the shares and pay income tax on the whole value at the point they exercise them (and become the legal owner of the shares).

• What if an employee exercises their unapproved options? How do buybacks work?

  Once an employee has exercised their shares, they become a legal shareholder and buybacks will work in accordance with your articles. This almost always gives the existing shareholders first rights. There is no open market for Ltd company shares to be traded on.

• Are my current articles of association compatible?

  If you have standard ‘model’ articles then yes, in most cases these are sufficient for issuing ‘exit only’ unapproved options. If however, you’d like to issue options that are exercisable before an exit event then you should ensure your articles include ‘drag and tag’ provisions. If you don’t have these you can use the Vestd articles for free which include this.

• Should there be any conditionality or performance criteria for vesting?

  Each unapproved share option award can include a unique and specific set of qualifying criteria. This could be as simple as ‘turn up each day’ or more specific and linked to key milestones like helping the business meet specific targets. What’s most important is that the criteria is clear and not subjective.

• How do vesting schedules work?

  Typically, when businesses use vesting schedules they set a years cliff (i.e. no shares can vest until after the first 12 months) and then the shares vest proportionally over a 3-5 year period.

  Some businesses like to get creative and front or back load the vesting and others like to increase the vesting frequency to quarterly or monthly (all of this is simple to create and manage using Vestd).

• When should recipients be able to buy their unapproved options?

  The choices are either ‘on exit’ or after they have vested, up to the end of any defined exercise period. Based on our latest data, 62% of companies opt for an  ‘on exit’ scheme, with the remaining 38% setting a specific time depending on their rationale and objectives for sharing ownership.

• Is an unapproved option definitely right for me given my specific situation?

  Depending on your situation you might also want to consider EMI options or growth shares as unapproved options tend to be the least tax-efficient for the recipient. Speak to one of our specialists (for free) to better understand what might be best for your situation.

• What exercise price should be set for the unapproved options?

  Typically you would either set the exercise price at the value of the shares at the time of issuance, or at their nominal value (the lowest possible price). This is a commercial decision for the business and will depend on specific circumstances. Book a call to get some free insight on how other companies typically do this.