Quick Insights: ESS Equity - Shares vs. Options

As we’ve discussed, equity compensation is a key strategy to attract, motivate, and retain top talent. But when it comes down to the nitty-gritty, should you offer shares directly, or are options the way to go? Both have their merits and considerations, and deciding between them can significantly impact your startup’s future and the engagement of your team. Let’s dive in to help you make an informed decision.

Shares: Ownership from Day One

Offering shares outright provides employees with immediate ownership in the company. This direct equity stake means employees benefit from dividends (if any) and have voting rights in company decisions.

Pros:

• Immediate Value: Employees receive something of immediate value that has the potential to grow over time.
• Simplified Process: Less complexity in administration compared to options, with no exercise price to worry about.

Cons:

• Upfront Tax Implications: Receiving shares can trigger an immediate tax liability for employees, based on the market value of the shares.
• Dilution: Issuing shares directly increases the total number of shares outstanding, potentially diluting the value of existing shares.

Options: The Promise of Future Shares

Options give employees the right to purchase shares at a set price after a certain period or upon meeting specific milestones. They’re not immediate ownership but a future opportunity to buy at today’s price.

Pros:

• Tax Efficiency: Generally, there are no upfront tax implications for receiving options. Taxes are due when options are exercised, potentially at a more favourable capital gains rate.
• Motivation & Retention: The “vesting” nature of options (where employees earn the right to exercise their options over time) can motivate employees to stay with the company and contribute to its growth.

Cons:

• Complexity: Options can be complex for employees to understand, especially regarding exercise prices, vesting schedules, and tax implications.
• Future Cost to Employees: Employees have to buy the shares at the exercise price, which might be a hurdle if the share price doesn’t increase as expected.

Making the Right Choice

Choosing the right equity compensation is a critical decision for your startup – one that should align with your startup’s goals, financial situation, and the message you want to send to your team. Shares offer immediate ownership and simplicity but come with upfront tax implications and dilution. Options, while more complex, offer tax advantages and can be a powerful tool for motivation and retention without immediate dilution.

Whether it’s shares or options, the goal is the same: to align your team’s efforts with the company’s success and share the rewards of your collective hard work. In the next Quick Insight in our Introduction to Employee Share Schemes series, we’ll dive into the how of setting up an ESS. Take a read!