The difference between share options and shares for small businesses

Share options are one way to give shares to employees. However, setting up a share option scheme is not always the best way to give equity to employees when you’re a small business. Most of us founders only even think about staff share options once in the lifetime of our company, and it’s easy to get confused about the best way forward.

I get asked about this by small business owners all the time, and I’ve been through it in different ways with my own companies. So this is one of my “from the trenches” articles to take you through the key questions of:

What are staff share options and how do they work
Share options vs shares
Alternative (and possibly cheaper and easier) ways you need to know when you’re thinking about employee shares options.

The business owners options about options

You have three main choices when you’re considering giving shares to your staff.

Just give your employees shares in the company

This is often the simpler, cheaper way to give shares to employees when you’re a small business, but there are a few things you need to know before you go ahead because there are a few expensive mistakes people make when they do this.

Learn about giving shares to employees

Set up a profit share scheme instead of giving shares

When I talk to business owners who want to incentivise staff, a simple profit share scheme is often the option we settle on because we don’t need all the legal hassle of giving equity away or setting up a formal company share option plan.

Employee share option plan

I’ll take you through exactly what share options are, how they work in the UK and when they’re a good idea (or not) for smaller businesses.

This article looks at the key differences to help you decide between share options vs shares or a profit share. And this will help you decide if you should set up a share option scheme for your company.

Let’s get into it..

What are share options?

Share options are a way of saying to staff, “When the company gets bigger, in a few years’ time, you can have the option of buying some shares at a price we agree now. That price will usually be cheaper than if you buy the shares today.”

It’s a bit like saying that you can buy a loaf of bread in Waitrose in 5 years’ time at what it costs today. Given that the bread and the shares are likely to be more expensive in 5 years time, this can be a bargain for staff in the future.

The difference between a share option scheme and giving shares to staff

Most of us think about shares as shares in a company on the stock exchange. You might already own shares in some of the big companies, like Tesco or Coca-Cola. Or we think about the shares in our company because you set up the company with a business partner, and you each have 50% of the shares.

These are all actual shares. A share option scheme is different because you don’t actually sell or give any real shares to your employees – you just let them have the chance to buy some shares at a lower cost in the future.

If you’re specifically here to talk about whether you should offer options or shares to your staff team, read on.

Why would you have a company share option scheme?

Share options schemes are used as a way of incentivising staff. You offer someone the option to buy the shares later at a discount because you want them to stick around. If you just gave them the straightforward choice of buying some shares in the company now, they might buy the shares and then leave. Which you probably don’t want your staff to do, especially as they would still own those shares you just gave them.

Not only do you want them to stay with the company, but you also want them to work hard and make a big contribution. Giving someone shares in the company, or the chance of buying shares at a discounted price later makes them feel like they’re part of the family, that if they work hard, they’ll benefit as the company grows.

We’re all looking for a win-win outcome here.

What are the advantages and disadvantages of share option schemes?

That depends. If you’re a little company, say three or four people, and you’d maybe like to grow to about a dozen people, then a company share option scheme might not be the right choice for you.

That’s because it takes quite a bit of setting up, plus legal and accountancy fees. You might want to think about the Enterprise Management Incentive share options as an easier way to do this if you’re still tempted, as the EMI scheme is simpler to set up. Or you might just want to give some shares to staff – see below for some alternatives to share options.

Where a company share option plan is a good idea

If you have big plans, maybe some investment already, and a team of people who you want to give shares, a share option plan or the EMI share options way of issuing shares could be good for you. But your plans will need to be pretty big to make it worthwhile for your staff.

Although a company share option scheme lets you offer your staff the option to buy shares later at a beneficial price, you have to think about whether they’ll want to and if this offer is truly to their advantage. It sounds good. But it can be one of those things you read about in a business book about fast-growing US tech companies, and assume that it’s what your company should do. That’s certainly the position I was in a few years ago when I was working in a tech company, and I thought that we should have a company share option scheme because that’s what Google-type companies do.

Learn from my experience at a tech company

If you’re building a company where you’re hiring new staff every month, doubling turnover every six months, and growing fast, like we were, you might think that offering share options to staff is a great way to get all the employees just as excited about the business as you are. That was definitely one of the thoughts in my head at the time.

Or you might want to set up an employee share option plan as a way of sharing the big money you are hoping to see in a few years. Lots of founders see giving share options as a way to be fair to the team who are working hard, especially when you don’t necessarily have the cash flow to pay them the big bucks right now.

Here’s why we didn’t set up a company share option scheme in my tech company

The paperwork would have cost a whole lot of money for lawyers. We preferred to spend this on developing the company. We paid for a new developer for a year with the legal fees we saved.
Talking to the lawyers and working out the best way to do it would have taken up quite a bit of my time as Operations Director when I should have been working on building the business.
It didn’t offer any real benefit to staff, as although we were growing fast, we didn’t know if we’d ever become big enough for a floatation or a sale.

The last of these is the big consideration in a share option scheme for staff.

Can staff sell their shares later?

If you give staff share options, this is only attractive if they can sell their shares later and make a sweet bundle of cash. This is the bit that you hear about people who worked for Google or one of the big tech companies which have floated on the stock exchange and got stock options. These staff members at Google would then be able to sell their shares on the open market years later because they had shares in a public company.

It’s only when your company floats on the stock exchange that people can publicly sell their shares on the open market to anyone who wants to buy them. If your company is likely to remain private, your staff will only be able to sell their shares to you (the owner) or the company. In fact, you’ll have written this into their shareholder’s agreement. And if you don’t have the cash to buy them, or you don’t want to, the shares and the share options are worthless to the employees until you sell the company.

Will employees care about share options?

I’ve spoken to a number of senior staff in smaller companies who have share options through a staff scheme, and they’re pretty unimpressed with the whole thing. Often staff don’t understand the whole idea of share options (why should they), or for the senior staff who you want to incentivise, the small proportion of shares and the fact that they’re locked up in the option scheme means that staff are left with a disgruntled feeling of “what’s in it for me?”

Many employee share option plans only allow the staff to exercise or vest their options when the company is sold. There’s a real risk that employees see the whole set-up as a sham because they have no real benefit from it unless the company is sold.

What about when you sell the company?

I often work with business owners who are aiming to grow their company to sell it in 5 or 10 years’ time. Having a share option scheme can be a little bit of a complication when it comes to selling the business because you’re not selling the whole company outright. Having staff with share options or additional shareholders wouldn’t stop anyone from buying your company if they wanted it, as long as all the paperwork is done correctly. But be aware that there is more paperwork to handle at that time.

Advantages and disadvantages of a share option scheme vs shares

Here’s a summing up of the advantages and disadvantages of share options vs shares

Advantages of share options vs shares

People can feel that they’re part of an exciting, growing business
You’ll get a cash injection when people exercise their share options and buy their shares, although that might not be for a few years
It can incentivise staff and make them feel part of the team
It will encourage key people to stick around, so it’s great when you’re competing for talent (although remember that eventually, they might leave once their options are due to vest)

To be honest, the advantages here only come if you actively communicate the share options as a way of making everyone feel that they are part of the company and that they will gain from it at some point.

Disadvantages of shares options vs shares

It’s a lot of work to think all of this through and work with the lawyers
Legal fees take money out of the business
If the business doesn’t end up floating, the shares may be effectively worthless to the staff unless you sell the company

There are some new, much simpler ways of handling the paperwork nowadays through companies that specialise in setting up share options for employees. But it does mean that the founders need to get their heads around the different decisions to be made. Many business owners I talk to end up realising that they have higher priority tasks on their to-do lists.

Advantages of giving shares vs share options

Just issuing shares to staff is much simpler and easier to set up, although you still want to protect yourself and get advice. Remember to read this article about giving shares
Giving shares is a lot easier to explain to staff than explaining options, which employees may see as esoteric and unreal

Disadvantages of giving shares vs share options

If your company is already making a decent profit, make sure that you don’t create a tax liability for your staff by giving them shares. Think about growth shares, or the EMI scheme instead if this might be the case for you
Make sure that you protect yourself and your company if anything happens to your employees or if they leave. You’ll need a shareholders agreement. More details of how to give shares while protecting yourself here…

If you need some help with shares in your business

I do quite a lot of work in this area, so if you’d like to talk about what’s the best option (excuse the pun) for your business, think about booking one of my business decision-making sessions. It could save you hours of thinking about this and thousands in legal fees.

strategy session