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What you must know about Employee Option Plans

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Many posts explain the logistics of creating an Option Scheme using a lawyer or someone like Seedlegals. This post tells you what you need to know as a founder when working with these people.

Working with lawyers

When you ask lawyers to draft a document as a Director, they believe that your aim is to defend the company as much as possible at all costs. As a result, they will share a very complicated template with you, containing many provisions that you don't understand. In many cases, it is fine that you can't understand all of these details. I believe that EMI/CSOP Option Schemes are a place where this is hugely counterproductive.

Our first EMI scheme document was created in 2017 when I had zero experience working with lawyers. As a result, I was scared to make changes and didn't fully understand all of the provisions. With a default employee option scheme, the template will 'defend the company' and, in the process, become very anti-employee, defeating the scheme's intent to an extent.

Q&A List for Lawyers on Option Schemes

When working with lawyers to create an EMI or similar Option Scheme, I would copy & paste this question list & send it to your lawyers. I think the default answers may surprise you.

  1. If an employee has options vesting over 4 years and leaves in the 5th year, what happens to their options or shares if there hasn't been an exit event? Is this a requirement of the scheme under HMRC or not?
  2. How long does an employee have to exercise their options after leaving the company? Is this a requirement of the scheme under HMRC?
  3. If an employee doesn't exercise their options and there is an exit event, what happens to the vesting? What does the employee have to pay, and what is the tax treatment?
  4. If an employee exercises their options in Year 4, leaves the company, and has an Exit Event in Year 7, what does the employee get, what does the employee have to pay, and what is the tax treatment?
  5. Can an employee vest their shares, leave the company & choose to exercise their options later? If not, why not?
  6. Can the scheme permit employees to exercise a fixed percentage of their vested shares if the board approves this? Do my articles of association allow the company to do this without needing further approval or pre-emption rights, etc.? Is it possible to have Board Discretion to create a partial Liquidity event?
  7. Does the scheme allow for cashless exercise & under what circumstances? Could a departing employee use a cashless exercise?
  8. Can employees, contractors, board members & directors all take shares based on this scheme?

Explainer of the Q&A

  1. If an employee has options vesting over 4 years and leaves in the 5th year, what happens to their options or shares if there hasn't been an exit event? Is this a requirement of the scheme under HMRC or not? Often, an employee will be forced to exercise the shares (paying considerable money upfront to exercise) and cannot keep the option & exercise it later if things go well. This means you're asking your team to stump up money upfront to keep the options that they have worked hard to earn.
  2. How long does an employee have to exercise their options after leaving the company? Is this a requirement of the scheme under HMRC or not? In an' unfriendly template, ' which, given the above context, is quite unfriendly, it can be as short as 30 days.
  3. If an employee hasn't already exercised their options and there is an exit event, what does the employee have to pay & what is the tax treatment? The decision around what vesting should happen & what the employee does is vital to explain it to your team.
  4. If an employee exercises their options in Year 4, leaves the company, and there is an Exit Event in Year 7, what does the employee get, what does the employee have to pay, and what is the tax treatment? The answer is the same as above.
  5. Can an employee vest their shares, leave the company & choose to exercise their options later? If not, why not? This links to point 2, but sometimes, there will be niche clauses that you want to catch in the template.
  6. Can the scheme permit employees to exercise a fixed percentage of their vested shares if the board approves this? Do my articles of association allow the company to do this without needing further approval or pre-emption rights, etc.? Is it possible to have Board Discretion to create a partial Liquidity event? This would allow you to provide partial liquidity to employees via a secondary stock sale if needed.
  7. Does the scheme allow for cashless exercise & under what circumstances? Could a departing employee use a cashless exercise? This would allow an employee to exercise options & get stock without having to pay money (instead sacrificing some options to avoid paying the upfront).
  8. Can employees, contractors, board members, and directors all take shares based on this scheme? It's worth noting if you plan to give board members or consultants equity.

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