What is a share option?

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A share option is the right, but not the obligation, given to an employee to buy a set number of shares in a company for a fixed price at a future date. Share options are granted by the company to eligible employees which may or may not be contingent on achieving specific targets. The number of shares to be acquired is at the discretion of the business and detailed in your Share Options Agreement. There is no obligation on employees to exercise their options, it is a personal investment decision. You can let the share options lapse.

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Purchasing ownership of a business you are working in can be a lucrative proposition depending on the business’s prospects for future growth and profitability. The fear of missing out can quickly turn to the joy of missing out should the business’s prospects for future growth and profitability not turn out as expected. In Ireland there are approved and unapproved share option schemes. The three types of Revenue approved share option schemes are:

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• Approved Profit-Sharing Schemes (APSS)
• Employee Share Ownership Trusts (ESOT’s)
• Save As You Earn (SAYE)

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The remainder of this post will focus on unapproved short option share option schemes. A short share option is within seven years whereas a long share option is more than seven years.

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Why are share options offered?

Share options are used to attract & retain talent. Share options aim to align the goals of the employer and employee by enabling employees to participate in the future financial success of the business. The success of the business is partly correlated to an employee’s productivity. The link between business success and personal financial gain is a strong motivator.

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How do share options work?

An employer grants you share options at a fixed price to be exercised at a future date. The period between the grant of your share options and exercising your options is known as the vesting period. A vesting period typically lasts four years beginning with a one-year cliff. A quarter or 25% of your share’s vests after year one. Thereafter, the remaining shares vest each month or 1/36^th at a time for the remaining three years. As shares vest the conditions in the share option agreement have been fulfilled and they can be exercised. If you resign from your position or fail to meet your targets you may lose your vested share options. Once vested and assuming the market value of the shares exceeds the grant price it is financially advantageous to exercise your share options.

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Example:

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Options granted: 10,000 shares.

Marginal Income Tax Rate: 40%

Universal Social Charge: 8%

Pay Related Social Insurance: 4%

Capital Gains Tax: 33%

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Price per share

Value

Grant option price of €1

€10,000

Options exercised at €4

€40,000

Shares sold after 5 years at €7

€70,000

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Gain on exercise of share option

Value

Exercise value

€40,000

Grant option price

€10,000

Gain

€30,000

Income tax on gain at 40%

€12,000

Universal Social Charge at 8%

€2,400

Pay related social insurance at 4%

€1,200

Gain after tax

€14,400

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Gain on selling of shares

Value

Shares sold after 5 years at €7

€70,000

Options exercised at €4 (Cost)

€40,000

Gain

€30,000

Personal Annual CGT Exemption

€1,270

Taxable gain

€28,730

CGT at 33%

€9,481

Gain after tax

€20,519

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A €10,000 investment yields €44,919 after income tax, USC, PRSI and CGT after nine years. The average annual investment return after tax is just over 18%. There is no tax due upon granting share options unless the term of the option exceeds seven years. There is no tax due upon vesting granted share options. There is income tax, universal social charge & pay related social insurance due when exercising share options. There is capital gains tax due when selling shares.

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Investment gains made on exercising attract income tax, universal social charge and pay related social insurance and must be paid within 30 days after the date of exercising. This is done by submitting a completed Form RTSO 1 to Revenue to the address specified on the bottom of the form and payment can be made through your myAccount, Revenue’s online service. You are also obliged to complete a Form 11 as part of your self-assessed annual tax return.

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Your ability to accurately value your exercised shares will depend on whether your company is publicly or privately traded. Publicly traded shares have a publicly traded price based on how public markets value the business. It is a highly liquid market. A liquid market is one in which it is quick and easy to buy and sell shares. Privately held shares are usually valued based on the latest private funding round, what private investors are willing to pay for shares based on the valuation of the business at that time. The price of privately held shares is less accurate and liquid than publicly traded shares. An illiquid market is one in which it is slow and cumbersome to buy and sell shares.

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An investment in one company comes with a high concentration of risk and reward. As a financial planner I don’t recommend investing more than 10% of your investable savings/assets into one company. The idea is, if it hits, it hits big but if it doesn’t, you’re not wiped out and live to fight another day. Investment markets can be very volatile, and this is only amplified further when investing in one company within one industry. This is especially true of some technology companies and their susceptibility to broader macro-economic cycles. There is also an element of market timing when it comes to share options which for the uninitiated is an incredibly precarious pursuit. It is luck or bad luck and not skill that determines your investment outcome.

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Where do share options fit into my personal finances?

Before evaluating your granted share options, evaluate your personal finances and financial goals. Are the risks and potential rewards of share options a good fit for what you want to achieve financially in the short, medium, and long term? Avoid borrowing to pay for share options. What you pay for your share options and your belief in the potential upside of the investment will play a large part in your decision making.

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Another major factor is at what life stage of the company’s existence are you being offered share options? Share options can be life-changing but it is also important to be cognizant of the statistics around business failures, growth, decline, mergers, and acquisitions. A business navigating, achieving, and maintaining escape velocity from startup to IPO is reserved for a select few.