Share Options Basics
ESOP [Employee Share (Stock) Option Plan]
A type of employee incentive plan in accordance to which the companies grant the share options to eligible option holders. ESOP usually outlines the main terms and conditions of the options program, and defines, for example, who is eligible to receive the options, what type of vesting is applicable, and how and when option holders can exercise their options.
Grant of the share options
It is the moment when a company offers its employees the share options. By granting the share options, the companies incentivise and reward employees for their contributions to the company's growth and success.
A legally binding document between a company and someone who gets share options. It lays out all the rules and details about those options, like when they are granted, what the details of the vesting schedule are, and how many options are granted.
A specific date when share options are awarded to an option holder.
Option holder (also called a Participant)
A person who has been granted share options by the company. The option holder can be an employee, consultant, director, or any other eligible person as determined by the company.
A designated number of shares set aside by a company for giving as share options to employees, consultants, or directors in the future.
Share option (also called an Option or Stock option)
A right granted by the company to acquire a specific number of shares in the company at an exercise price. With share options, option holders can potentially benefit from an increase in the company's value over time.
Virtual (also called Phantom) options
A form of employee incentive that grants employees or contractors the right to receive a cash payment or other equivalent benefits based on the value of a company’s shares over a specific period. Unlike traditional share options, virtual options do not involve (at first) the direct ownership of a company’s shares.
VSOP (Virtual Share Option Plan)
A type of employee incentive plan in accordance with which the companies grant to the eligible participants the virtual share options. Compared to ESOP, it usually requires less administrative work to set up, but at the same time, it typically does not provide any tax benefits to holders of such virtual options.
A type of vesting that allows an option holder to gain ownership rights to their share options faster than determined by the vesting schedule, often triggered by specific events like a change in control, merger, or acquisition (selling the company).
An initial phase of a vesting period, usually lasting up to 1 year, during which an option holder won't get any share options yet. After the cliff period, the option holder starts earning the share options gradually.
A process where option holders gradually earn ownership rights to their share options. It could be either over a specific period (time-based vesting) or based on predetermined conditions, such as certain targets or milestones (performance-based vesting).
An overall timeframe, usually lasting from 3 to 5 years, over which an option holder gradually earns ownership rights to its share options.
Vesting start date
A date from which the vesting period for share options begins, often coinciding with the employment start date or the grant date.
A specific timeline or set of conditions that determine when an option holder gains ownership rights over granted share options. Depending on the type of vesting, the vesting schedule could be either tied to a period of time or to fulfilment of certain conditions.
Exercising and Sale
Exercise of the share options
A process of purchasing company shares at an exercise price, by an option holder, allowing them to convert the share options into actual ownership of the shares. Exercising the share options means that the option holder becomes a shareholder of the company and might need to adhere to shareholders’ agreements and follow other instructions given by the company to finalise the exercise.
Exercise event (also called a Liquidity event)
A certain event that may additionally to the exercise period, trigger the exercise of the share options, such as a merger, a secondary sale, an acquisition, an initial public offering (IPO), or the sale of the company.
A period during which the share options should be exercised otherwise they could lapse without compensation.
Exercise price (also called a Strike price or Subscription price)
A price that needs to be paid in order to buy or subscribe for the shares, i.e. to exercise the share options.
An option holder whose employment or service agreement is terminated under unfavourable circumstances, typically because its acts or combinations of acts are material breaches of laws or contracts with the company. Usually, in such cases share options terminate completely and entirely, even with respect to the vested portion of the share options.
A right of the company to request an option holder to transfer shares acquired under share option plan back to the company or its shareholders. This transfer can occur at a fair market value, a discounted price, or at an agreed-upon price.
An option holder whose employment is terminated under acceptable to the company circumstances, such as retirement, disability, or death. Usually, in such cases option holder is entitled to all vested options but all unvested share options shall forfeit.
Post-termination exercise period
A defined timeframe during which an option holder can exercise its vested share options after the termination of the employment or service agreement with the company. This period typically starts from the date of termination and extends for a specific timeframe, such as 90 days or 12 months.
Termination of the share options
Expiration of the rights associated with share options. It occurs for different reasons, for example when you leave the company or when a specific timeframe ends.
Tax and Financial Considerations
Capital gains tax
In the context of share options, it is the tax you must pay when you sell your shares or share options. Capital gain is the profit you make from selling any assets, so the tax is usually paid on the difference between the selling and buying price.
Fair Market Value (FMV)
Value of an asset (e.g. shares) at the open market. It is the price you could get if you sell your shares to any independent party. Fair market value is used to determine the amount of the benefit when you exercise your options and get the shares.
The amount of tax the payer must deduct from payment and transfer to the tax authority. It is not a separate tax but a way of collecting income tax from the source where it is paid from. For example, the employer is usually obliged to withhold income tax on the salaries paid to the employees. It is the tax on the employee's income that employers deduct and pay to the tax authority to simplify tax collection.
A term often used to describe the difference between the exercise price and the fair market value of the shares at the time of exercise. The spread represents the potential benefit an option holder gets by exercising stock options.
A non-cash benefit that an employee receives from the employer in addition to salary. It is also called benefits in kind or simply - perks. For example, an equity reward or a share option is a benefit in kind if it is given for free or at a discounted price. The fringe benefits are usually taxed as a salary.
A non-cash benefit that is considered taxable income while no actual money is received to pay the tax bill. It is often a result of share option taxation at the time of their exercise. The receipt of shares is a taxable event but taxes on it must be paid with actual money.