How do stock options work? UK guide

Hunting for a new job or just started at a new company? You’ll need to know about the different benefits on offer, which could include stock options.

Also known as share options here in the UK, this is a type of employee share scheme (ESS) sometimes offered by companies to employees. But how do stock options work, and are they worth having?

Find out everything you need to know here in our essential guide to stock options in the UK.

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What are stock options?

Stock options or share options are a type of employee share scheme (ESS). They give employees the right to buy shares in the company they work for at a future date.

The company sets a price that the shares can be bought for, and this doesn’t change even if the price of the shares increases later.

So the employee isn’t given the shares directly - only the right to buy them.

Share options are designed to reward and incentivise employees, enabling them to own equity in the company and therefore a personal interest in how well it performs.

And that’s essentially stock options explained, although each scheme can have its own complexities, conditions and policies.

Types of employee stock options (ESOs)

There are a couple of different types of employee stock options (ESO) schemes that companies can choose from.

These are enterprise management incentive (EMI) stock option plans, and company share options plans (CSOPs).

Enterprise management incentives (EMI) options¹

EMI options schemes are backed by HMRC and used for UK PAYE employees. Only companies that meet certain requirements can grant EMI options though. For example, the company needs to have assets of less than £30m, be independent and have no more than 250 full-time employees.

Company share option plans (CSOPs)¹

CSOPs grant employees options to buy shares either in the company that employs them, or its parent company (if applicable). It’s another HMRC-approved scheme, one that offers income tax and NICs relief when options are exercised, provided that certain conditions are met.

Alternatives to stock options

Companies can also choose to implement other kinds of stock-related employee benefits.

The most popular used in the UK are Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs).

Restricted Stock Awards (RSAs)²

RSAs are a type of employee compensation where staff are granted company stock which has certain restrictions.

Once granted a RSA, the employee is directly given stock and becomes the legal owner of the shares. However, it's called restricted stock because it can’t be freely traded or transferred.

Over time, during what is known as a ‘vesting period’, the employee may earn full rights over the shares. This will affect what happens to them when they leave the company - i.e. whether they retain ownership of them or the company repurchases them.

Restricted Stock Units (RSUs)

Restricted Stock Units (RSUs) are another kind of employee compensation or benefit issued by a company.

A company may want to offer them as an incentive for new employees, helping them secure the best talent. Or they may grant RSUs to staff on different occasions, such as on an annual basis, to reward long service or when the company reaches a particular milestone or performance-related target.

The key thing to note is that RSUs don’t have monetary value at the time they’re granted. After a set period of time known as a ‘vesting period’, the RSU will convert to actual stock which can be sold for a cash value.

How do employee stock options (ESOs) work in the UK?

If an employee is granted stock options, they will often be given a preset price and a fixed date for when they can purchase shares. They may also be given a vesting schedule, which outlines the key dates when share options are granted and when they can be exercised.³

However, different businesses use their own policies and procedures to run ESO schemes - so how it works can vary between companies.

Calculating what your stock options might be worth

It’s not always simple to calculate the value of your stock options as an employee. This is because it can depend on a few fluctuating factors, such as the company’s valuation which changes over time.

You can, however, make an informed estimate based on the value of your stock options on the day they are granted. Here’s what to do:³

1. Use the preset price in your share option agreement (often called the ‘strike’ price) and the company’s current share price.
2. Find the difference between these two prices.
3. Multiply each price by the number of options you’ve been given.
4. This is roughly what your share options would be worth if they were fully vested and exercised today.

How to exercise and sell your stock options

You can only sell your shares once they are fully vested, which will happen according to the company’s vesting schedule.

When this happens, you can ‘exercise’ your options, which essentially means buying them at the preset price given at the time they were granted.

You’ll become the legal owner, and can sell your shares if you wish.

How are stock options taxed?

How stock options are taxed all depends on the type of scheme.

For EMIs, employees won’t have to pay income tax or NICs when the options are granted. And if they exercise their options in line with HMRC requirements, they won’t pay tax at that stage either.

Capital gains tax may still be due when shares are sold, but there are circumstances where the rate can be reduced. For example, if the shares are held for at least 2 years.⁴

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FAQs on employee stock options

What is the difference between employee stock options and RSUs?

RSUs grant the employee the stock directly, although a vesting period is common until the employee actually owns the stock.

Stock options simply give the employee the right to buy shares in the company, and usually at a specific price and before a certain date.

Read more about the difference between stock options and RSUs.

What are the benefits of ESOs for employees?

The advantages of ESOs for employees include the following:

• Financial rewards if the company performs well and shares increase in price
• Your performance at work can have a direct impact on the value of your stock - which can be quite motivating!
• Tax benefits if your company uses a HMRC-approved scheme.

How do stock options work after you leave a job?

There are three different things that can happen to stock options when an employee leaves a job. In EMI schemes, options can be lost/lapsed, kept or exercised.⁵

What exactly will happen will be set out in the employee’s share option agreement. It may depend on the circumstances under which the employee is leaving - essentially, whether the employee resigns or is terminated.

If options are to be exercised, there may be a deadline of around 90 days (after leaving) in which this can be done.⁵

How do LLCs handle equity?

Limited liability companies (LLCs) have a different business structure to limited companies (LTDs). Because of this, they don’t issue stock options. Alternatives may be used as part of employee benefit schemes though, such as profits interest units (PIUs) or Membership units.⁶

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Sources used:

1. Harper James - description of EMIs and CSOPs
2. Carta - Restricted Stock Awards (RSA) and how they work
3. Carta - how share options work
4. Seed Legals - how to calculate value of share options
5. Harper James - stock options when an employee leaves
6. Carta - how LLCs handle equity

Sources last checked on date: 10-Oct-2024