Unapproved – share option schemes
Unapproved options can be really useful if you need an extremely flexible scheme that can be issued to employees, contractors, advisors or consultants. It's not as tax advantageous as an EMI option scheme, however, unapproved schemes do not have to meet any statutory requirements or limits, do not require HMRC approval or that employees work more than 75% of their time with the business.
Why do businesses use unapproved share options?
- Attract and retain the best people even if not employees
- Align interests by giving recipients a sense of ownership
- Reward those who help you grow the business by enabling them to share in its success
What is an unapproved share option scheme?
Unapproved options are flexible and can be given to employees, contractors, advisors, and consultants. 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 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 shares are readily convertible to cash at the point of exercise (in a sale scenario, for example).
What are the main advantages?
- Unapproved options can be awarded to consultants, non-executive directors and other employees who are not eligible for HMRC approved options.
- There are no limits to the number of options that can be given in total or to an individual.
- They do not require a pre-defined value of the business to be set.
- Options do not require any formal valuation or notification to HMRC when they’re issued (unlike EMI), although they do need to be included in an annual report to HMRC via ERS if they have been given to employees or directors.
- You can set conditions for recipients, such as achieving milestones, or staying with the company for an agreed period of me.
What are the main disadvantages?
- Recipients have to pay Income Tax based on the value of the shares (less what they pay for them) when they exercise them.
- There is no Entrepreneurs’ Relief, so the normal rate of Capital Gains Tax will need to be paid once sold.
We often get questions whilst helping customers set up their unapproved share schemes. Here are the most common, which might clear a few things up while you explore your options. If you need further explanation or have additional questions we’d love to help. Speak to one of our specialists for free...
Do I need to get a valuation done before distributing unapproved options?
No, for unapproved options you do not need to get a valuation done pre-issuance as the recipient pays no tax on receipt of the options, but will pay income tax on exercise, based on the difference between the market value of the shares (at that time), and the price paid for them.
When does the recipient pay tax?
In cases where these shares are not readily convertible into cash, only income tax (and not NI) is due and declared in the recipients self-assessment tax return for the tax year in which the option is exercised.
What exercise price should be set for the shares?
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).
So, does that mean I could 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 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 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 shares?
The choices are either ‘on exit’ or after they have vested, up to the end of any defined exercise period. 80% of companies tend to choose ‘on exit’ and around 20% will set a specific time depending on their rationale and objectives for sharing ownership. The team at Vestd would be happy to share insight.
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 shares?
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. (Speak to one of our share scheme specialists about this.)
Give Vestd a try!
Vestd is the UK’s first share scheme management platform for SMEs.
It is the easiest, simplest and most cost effective way to create an unapproved share scheme for your business.
The process of giving or receiving shares in a private limited company used to be extremely cumbersome, expensive and confusing!