What is a Share Option?

A share option is a right to buy shares at some point in the future. If a person or an employee is granted an ‘option’, it means they can choose, if they wish, to exercise that option to purchase a certain number of shares in a company.

Often, share options are given according to ‘vesting rules’. The ‘vesting rules’ explain when the options may be ‘exercised’ (meaning when they can be bought or, sometimes received for free, by the recipient). One of the most commonly used vesting rules for employee share options is called a ‘four-year vest with a one year cliff’. (Don’t worry, we’re about to find out what that actually means in plain English…)

This phrase simply means that the total number of shares which are covered by the options vest over the period of four years (usually spread equally, for example, 1/48th of the total number of the options vest each month over the four year period.) The one year cliff refers to the fact that if the employee leaves their job during the first year, they’ll get nothing.

However, after the cliff period has finished, i.e. from year two onwards, these share options will start to vest automatically, so if the employee leaves, they should still be entitled to exercise the share options which have vested by that point.

Share options are usually granted under the terms of a Share Option Scheme, which is usually a single document (although it could be spread over a number of documents) which sets out the rules for:

• how many shares are covered by the share option,

• over what period the option vests, and

• the purchase price of the shares.

Share options can also be granted in such a way that once they’ve vested, the employee automatically receives the relevant number of shares without having to pay any money for them.

Alternatively, a share option can include what are sometimes referred to as a ‘strike price’, which simply means the purchase price or subscription price which the recipient of the share option must pay if he wants to exercise the share option (and therefore buy these shares). The strike price is usually below the market value of the shares, to give the recipient an incentive to exercise the share option and purchase the company’s shares.

Another often-used way of granting share options is to grant options which vest only in the event that the company is sold. This can be useful for companies which do not perhaps want their employees holding shares, but to do want them to benefit from a windfall if the company is sold at a decent profit.