For small business owners and entrepreneurs, equity incentives can be an effective tool to attract, retain, and motivate employees and investors by issuing shares which can be realised when you sell your business. However, understanding the difference between share options and shares is crucial for making informed business decisions. This article explores the key distinctions between these two forms of equity and their implications for small businesses.
What Are Shares?
Shares represent ownership in a company. When an individual holds shares, they own a portion of the business and may have voting rights and dividend entitlements, depending on the type of shares issued and the articles of association or shareholders agreement.
Key Features of Shares:
- The shareholder becomes a part-owner of the company upon receiving shares.
- Some shares grant the holder the right to vote on company matters.
- Shareholders may receive a portion of the company’s profits as dividends.
- Shares can be sold or transferred, subject to company restrictions.
When Small Businesses Issue Shares:
- To raise capital from investors.
- To reward and retain key employees through equity stakes.
- To distribute ownership among founders and early-stage team members.
What Are Share Options?
Share options, often referred to as stock options or share incentives, give an individual the right (but not the obligation) to buy shares in the company at a predetermined price (the “exercise price”) at a future date.
Key Features of Share Options:
- The recipient does not own shares until they choose to exercise the option.
- Many options come with conditions, such as a vesting period, requiring the recipient to remain with the company for a certain period before they can exercise their options.
- Share options can be structured to offer tax benefits, such as through an Enterprise Management Incentive (EMI) scheme in the UK.
- Encourages employees to contribute to the company’s growth, as the value of their options increases if the company performs well.
When Small Businesses Use Share Options:
- To attract and retain talent without giving away immediate ownership.
- To incentivise employees based on the company’s long-term success.
- When cash flow is limited, and equity compensation is a viable alternative to salary increases.
Key Differences Between Shares and Share Options
| Feature | Shares | Share Options |
|---|---|---|
| Ownership | Immediate upon issuance | Only upon exercising the option |
| Cost to Holder | No cost (unless purchased) | Requires payment at exercise |
| Voting Rights | Usually granted | Not granted until exercised |
| Dividend Rights | Eligible if issued | Not eligible until exercised |
| Tax Treatment | Subject to capital gains tax on sale and may attract employment-related securities taxation if an employee is issued shares. | May be taxed at exercise but often is tax effective. |
| Flexibility | May be transferred/sold if allowed by shareholder agreement | Typically non-transferable |
Which Option is Best for Your Business?
- Shares are better suited for investors, founders, and senior employees who need immediate ownership and influence in the company.
- Share Options work well for incentivising employees over the long term, ensuring they stay committed to the business’s success.
Final Thoughts
Both shares and share options can be powerful tools for small businesses, but choosing the right approach depends on your business goals, financial strategy, and legal considerations. Understanding the differences and seeking professional guidance ensures you structure your equity incentives effectively.
For expert advice on structuring equity and incentive plans for your business, CJPI provides strategic consulting to help small businesses navigate these decisions, as well as strategy advice for corporations.
