Share options are commonly given to employees as a reward or incentive. When the shares are fully “vested” it means that they are fully owned by the employee after a certain period of time or if certain conditions are met.
With a myriad of terms like ‘time-based vesting,’ ‘vesting schedules’, ‘equity compensation’ and ‘restricted stock units,’ it can seem overwhelming.
However, these concepts play a significant role in shaping the financial futures of employees and the growth trajectory of companies.
Overview of Share Options
Share Options are a form of equity compensation, which employees earn over a set option or vesting period.
This is usually defined in a vesting schedule that outlines when and how the shares will vest.
Essentially, when an employee’s shares are fully vested, they have complete ownership of these shares and can choose to sell them. Companies often use share options as a strategy for employee retention, as they tie the employee’s rewards to their tenure at the company and often, their performance.
Vesting schedules
Vesting schedules vary, but a typical vesting schedule might see an employee fully vested after four years, with a one-year “cliff”.
That means that no shares vest until the one-year mark, at which point a large chunk (for example, 25%) suddenly vests. After this “cliff”, the remaining shares might vest monthly.
The most common types of vesting schedule include time-based vesting, cliff vesting, and graduated vesting.
Time-based vesting
Time-based vesting is often the go-to choice for startups and established businesses. Here, employees earn their share of equity over a specified period, typically four years.
This period often includes a one-year “cliff”, meaning the employee must stay with the company for at least a year before any shares vest. This approach is designed to encourage longevity and commitment within the company.
Cliff vesting
This involves a waiting period (the ‘cliff’) after which an employee suddenly becomes vested in a significant portion, or all, of their equity. This can act as a powerful incentive for employees to stick around and contribute to the company’s growth.
Graduated vesting
Graduated vesting is a more flexible model, where the percentage of vested equity increases over time. This model rewards employee loyalty and continuous contribution to the business.
Choosing the right vesting schedule depends on various factors, including the nature of your business, its growth phase, and the kind of talent you want to attract and retain.
Making informed decisions in this arena can significantly impact your company’s success and your employees’ financial wellbeing.
For businesses in Ireland
Irish law provides a clear and comprehensive framework for granting, managing, and transferring share options. One key aspect of this is the use of Restricted Share Plans. Under these plans, an employer can apply performance or time-based vesting to restricted shares for a period after the grant.
This approach aligns employee rewards with their performance and the passage of time, reinforcing their commitment to the company’s success.
An important tax-related aspect of share options in Ireland is the treatment of Restricted Stock Units (RSUs). If the RSUs vest and the holder is no longer an Irish resident, the RSUs may not be taxable in Ireland. Conversely, RSUs may be fully taxable if they vest at a time when the holder is an Irish tax resident.
Irish law provides for “tax-free” or “tax-efficient” employee share schemes. These schemes can offer significant tax savings to employees, thereby enhancing the attractiveness of these incentives.
Practical implications for stakeholders
Share options have significant implications for business owners in Ireland.
They can be a powerful tool for attracting and retaining skilled employees, as the promise of future equity ownership can be very appealing.
For shareholders, selling or buying vested shares can be a complex process, requiring a clear understanding of the vesting schedule and the tax implications of the sale.
Directors also need to understand share options, as they often form a significant part of employee compensation packages, and directors have a fiduciary duty to act in the best interests of the company.
Key considerations when establishing a Vesting Schedule
There are several strategic and practical aspects to consider:
- Defining Clear Vesting Periods: The timeframe for equity to vest is usually linear, with 25% immediately following the one-year cliff, 50% after two years, 75% after three years, and 100% after four years. It’s crucial to define these periods clearly to avoid any misunderstandings.
- Fairness and Transparency: The vesting schedule needs to be fair and transparent. This includes considering the treatment of an employee who leaves quickly to prevent them from benefiting disproportionately from others’ work.
- Tax Implications: Be aware of the tax implications for the employee. For instance, Restricted Stock Units (RSUs) are fully taxable if they vest at a time when the holder is an Irish tax resident.
- Communication: A common pitfall is not clearly communicating the vesting schedule and terms to employees. This can lead to confusion and potential legal issues down the line. Make sure to provide comprehensive information about the vesting schedule, including the conditions under which shares vest and the tax implications.
- Vesting Conditions: Different types of vesting conditions can be applied, including performance-based conditions and service-based conditions. Choose the one that best aligns with your company’s objectives and the nature of the role.
- Negotiating Leaver Provisions: Leaver provisions determine what happens to an employee’s unvested shares when they leave the company. These need to be negotiated carefully and communicated clearly to avoid any future disputes.
The impact of share options on business sales and acquisitions.
Share options hold significant influence in business sales and acquisitions. They represent a claim on future earnings and can materially affect the company’s valuation.
- Effects on Valuation: Share options are part of a company’s equity structure and can carry weight in determining its overall value. Buyers will often consider the volume of share options during due diligence as it can indicate the level of employee commitment and potential future costs.
- Transaction Complications: The status of share options can complicate the transaction process. For instance, when a company is acquired, the acquiring company could potentially cancel the unvested grants. This is because, technically, employees haven’t “earned” these shares yet.
- Due Diligence: Buyers need to conduct thorough due diligence to understand the implications of any share option. This includes understanding the vesting schedule, assessing the tax implications, and determining the impact on the purchase price.
- Legal Compliance: Sellers must ensure that they comply with all legal requirements when transferring vested shares. This includes honouring any contractual obligations inherited from the target company.
- Employee Impact: The treatment of share options during an acquisition can significantly impact employee morale and retention. In some cases, the acquiring company might accelerate the vesting of shares or offer a ‘rollover’ of equity into the new company. These decisions can influence whether key employees stay on after the acquisition.
- Equity Compensation: If a company’s equity compensation includes Restricted Stock Units (RSUs), these too can be affected during an acquisition. The new company might assume the RSUs, replace them with its own, or cash them out.
Understanding share options in Ireland is a complex but necessary task for business owners, shareholders, and directors. As these shares become an increasingly common part of compensation packages, it’s crucial for stakeholders to stay informed and consult legal experts when necessary. The world of vested shares can be challenging to navigate, but with the right knowledge and resources, it’s possible to use them to drive growth and success for your business.
What does it mean to have vested shares?
Having share options essentially means that an employee has earned the right to keep shares or stock options, which are given as a form of compensation, even after leaving the company. Vesting is typically based on duration of employment or meeting performance milestones. Until the shares have vested, they cannot be sold or transferred. If an employee leaves the company before the shares vest, they typically forfeit those shares back to the company. The vesting schedule, which outlines when and how shares will vest, is usually outlined in the employee’s contract. It provides a significant incentive for employees to stay with the company and contribute to its success, as the value of the shares may increase over time.
Can share options be sold?
Yes, share options can be sold. Once shares have vested, they become the full property of the holder and can be sold at their discretion. However, selling vested shares may have tax implications, and company-specific restrictions may apply. For instance, there may be a specified period known as a ‘lock-up’ during which vested shares cannot be sold. It’s important for employees to understand these conditions and consult a financial advisor or legal expert before proceeding with the sale of vested shares.
Do I keep vested shares if I leave?
Yes, typically employees do keep their vested shares if they leave the company. As the shares are considered ‘vested’, they are owned outright by the employee and are not subject to forfeiture. However, the specifics may vary depending on the individual company’s policy and the terms of the employee’s contract. Some companies may offer a ‘buy-back’ provision that allows them to purchase vested shares from departing employees. It’s always recommended that employees thoroughly understand their contract and consult a legal advisor if necessary.
What is the difference between vested and exercised shares?
Vested shares and exercised shares represent two different stages in the process of acquiring equity in a company. When a share is “vested,” it means that an employee has earned the right to own it after a certain period of time or upon meeting certain conditions, but they don’t necessarily own the share yet. This means they cannot sell or transfer it.
On the other hand, “exercising” a share refers to the act of purchasing the share at a predetermined price (also known as the exercise or strike price), usually after it has vested. Exercising is the step that follows vesting in the case of stock options. Once a vested option is exercised, the shares typically become the full property of the holder and can be sold or held as they see fit, subject to any company-specific restrictions or tax implications.
