In the past, companies expected job loyalty but today we hear stories of employees accepting other job offers only a few months after being hired. As employers are aggressively competing for the best talent by offering higher salary, remote work opportunities, discounted meals, football tables, and many more short-lived excitement opportunities, the long-term solution is an employee share option scheme. This is an excellent tool to align the interests of founders, management teams, and employees and for everyone to have a collective investment in the company’s future. Options are especially beneficial for start-ups for whom this can be one of the main ways to attract the best talents while maintaining their loyalty, real engagement and motivation.
What is the share option?
The share option is a right to acquire a certain amount of the company’s shares after some time in the future at a pre-agreed price or free of charge. So the employees receive a right to exercise their share options, i.e., to buy the shares after a specified period of time at the price fixed at the date when the options were given to the employee regardless of the prevailing market price. The employer can make the granting and exercising of share options dependent on certain targets such as performance indicators, sales targets, i. e., the employee will have a right to exercise their share options provided that the set targets are met at the agreed rate for that period.
Among the most outstanding examples of the application of options is the Lithuanian start-up Vinted, whose employees are motivated by the company’s shares. Loreta Andziulytė, the partner of ECOVIS ProventusLaw, points out that this method of employee encouragement is often chosen by FinTech companies as well. “Although options as a means of encouragement are especially popular abroad, more and more Lithuanian companies discover them as well. We also have such examples among our FinTech clients, who first choose to encourage employees who work longer or hold higher positions”, says L. Andziulytė.
How share option is beneficial both for the employer and the employee?
Employers who already offer employee share options notice increased loyalty of employees and a more active contribution to the company’s success. Many international examples show that it is one of the best tools in building a motivated team.
Some companies choose to offer share options to the key employees ensuring that the company’s strategy is executed by the team that has a long-standing history with the company while others offer share options to all employees. The common goal of both parties of the share options agreement is to motivate the employee to take a long-term approach, thus increasing the value of the employer as the company, and aligning the interests of the parties. The share options are of a purely personal nature and are inextricably linked with the employee as the employee of the particular company. The company is willing to have the employment relationship as long as possible, therefore, usually, the crucial condition is to set forth the long-term after which the employees may exercise their right to acquire the shares of the company.
Taxation of employee share options
Share options are taxed as fringe benefits.
- Applicable taxes are paid by the employer.
- Applicable income tax and social security contributions are of the same rates that are applied to salary, except tax exemption.
- Applicable tax exemption is applied for income tax and social security contributions if a share option is held (but not exercised) by an employee for at least 3 years. The fringe benefits from share options are exempt from personal income tax provided that a share option agreement is concluded after 1 February 2020.
- Taxation is applicable not at the moment of granting the share option but only when the share options are exercised.
- Taxable value is a difference between the fair market value of the shares and the price paid by the employee for the shares.
Capital gain received by the employee after selling acquired shares is taxed.
- Applicable taxes are paid by the employee.
- Applicable personal income tax. Capital gain is taxed at 15-20% of the personal income tax compared to 20-32% applicable to the salary.
- Taxable value is a difference between the sale price of the shares and the price paid by the employee for the shares. In case the employer has paid the applicable taxes for the shares upon exercise of the share options then the taxable base is the difference between the price at which the shares are further sold and the value of the shares from which the employer has paid the applicable taxes. For example, the employee received the shares for 1,000 EUR and later he/she sold them for 2,500 EUR, it means that the taxable value is 1,500 EUR.
Law firm ECOVIS ProventusLaw has over 10 years of experience in labour and corporate law consulting, dispute resolution among shareholders, drafting shareholder option agreements. If you intend to introduce an employee share option scheme and apply related employee retention and motivation benefits, please do not hesitate to contact us. We will advise on the best way to design and properly implement such a scheme.
The content of this article is intended to provide a general guide to the subject matter. The expert should be consulted for assessment of the specific situation.
Prepared by an attorney at law Mrs. Loreta Andziulytė and senior associate Ms. Milda Šlekytė
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