By Sanchit Paul
Introduction
Share option plans have become a popular form of employee compensation in the corporate world. These plans provide employees and directors with the opportunity to purchase company shares at a predetermined price within a specified timeframe. While share option plans can be beneficial, it is crucial for individuals to understand the legal risks associated with these arrangements before entering into any agreements.
What is a Share Option?
A share option is a contractual agreement that grants an individual the right, but not the obligation, to purchase a specific number of shares in a company at a predetermined price, known as the exercise or strike price. The exercise period, during which the option can be exercised, is typically set for a specific duration, encouraging employees to remain with the company.
How Does it Work?
When an employee or director exercises their share option, they acquire shares at the predetermined price, which is often lower than the market value. The difference between the exercise price and the market value at the time of exercise represents a potential financial benefit to the option holder. Employees can choose to sell the shares immediately or retain them for potential future gains.
Benefits of Share Option Plans
Share option plans offer several advantages to both employees and companies. For employees, share options can provide an opportunity to share in the company’s success and potentially earn significant financial rewards. They can also foster employee loyalty, aligning the interests of employees with those of the company’s shareholders. From the company’s perspective, share option plans can attract and retain talented individuals, incentivise performance, and align the interests of employees with those of the company’s shareholders.
Key Considerations for Employees and Directors
Before signing any share option agreement, employees and directors should carefully consider the following key points:
Terms and Conditions: Carefully examine the terms and conditions outlined in the share option plan, including the exercise price, exercise period, and any restrictions associated with the shares. It is important to acknowledge that the value of share options can be uncertain, especially considering the possibility of the company’s dissolution or underperformance during economic downturns. When contemplating the exercise of share options, it becomes necessary to strike a balance between the potential benefits of owning shares and the stability provided by a regular salary.
Vesting Schedule: A vesting schedule determines the timeline or conditions under which employees or directors become entitled to exercise their share options. It is designed to incentivize long-term commitment to the company. For example, a typical vesting schedule may require employees to work for a certain period, such as three years, before they can exercise a percentage of their options. Understanding the vesting schedule is important as it influences when and to what extent an individual can benefit from the share option plan.
Tax Implications: Seek professional advice regarding the tax implications of participating in a share option plan, as there may be income tax, capital gains tax, and fringe benefits tax considerations. The timing of tax may apply at the time of option grant, vesting period, and/or at the exercise or sale of the shares. Employees might be eligible for deductions or tax credits related to their share option exercise or the sale of shares. Being aware of these can help in optimizing one’s tax position.
For employees working across borders or for multinational corporations, there might be additional complexities related to double taxation or tax treaties. It’s essential to seek advice on these matters to avoid unintended tax consequences.
Valuation and Market Risks: Understand that the value of shares can fluctuate and may be influenced by various factors such as market conditions, company performance, and industry trends. Consider the potential risks and rewards associated with holding company shares.
Employment Considerations: Evaluate the impact of the share option plan on employment rights, including any potential changes to employment contracts, termination provisions, or post-employment restrictions. These may include but are not limited to:
- Expiry upon Termination: Some share option agreements stipulate that any unexercised options will expire immediately or shortly after the termination of employment. This can be a significant loss for employees, especially if they were close to their vesting dates.
- Reason for Termination: The circumstances surrounding an employee’s departure can influence their rights to share options. For instance, options might be treated differently if an employee is terminated for cause versus a voluntary resignation or redundancy.
- Post-Termination Exercise Period: Some agreements allow for a grace period after termination during which employees can exercise their vested options. The length of this period can vary, but it’s crucial for employees to be aware of this timeframe.
- Clawback Provisions: In certain situations, companies might have the right to “claw back” or reclaim benefits from share options if an employee engages in misconduct or breaches specific contractual obligations.
Share Dilution: Share option plans can lead to share dilution, which occurs when new shares are issued as a result of exercising options. and directors should consider the potentially dilutive effects of the share option plan, as it may affect the percentage of ownership they hold in the company. Dilution can be significant, especially in cases where the share option plan is widely offered to employees or the company experiences substantial growth.
Corporate Governance: Familiarize yourself with the company’s corporate governance practices and understand how share option plans are administered and governed within the organization.
Conclusion
Share option plans can be an attractive form of employee compensation, providing individuals with the opportunity to participate in a company’s growth and success. However, it is essential for employees and directors to be aware of the legal risks associated with these plans. By carefully considering the terms and conditions, tax implications, valuation risks, employment considerations, and corporate governance aspects, individuals can make informed decisions when participating in share option plans. Seeking legal and financial advice is crucial to fully understand the legal implications and potential risks involved.
This article provides general information and should not be construed as legal advice. At Foulsham and Geddes, we provide advice in relation to all aspects of contract law. We know how to draft and review employment contracts in the client’s best interests and can provide strategic advice in relation to negotiating the terms of any share option offers.
If you need help drafting or advice on any such agreement, or otherwise have any questions regarding your rights and responsibilities when it comes to your employment or contractor work, please contact one of our lawyers on (02) 9232 8033 or via e-mail at fg@fglaw.com.au