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. This is especially painful for start-ups that are building organizations and processes on the go and typically do not have sufficient resources to constantly train new people and rely significantly on the loyalty of employees to retain the knowledge. Competitive base salary is not the only mean of encouraging an employee to dedicate themselves to work required for fast-paced company growth. As employers are aggressively competing for the best talent by offering 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 founder’s, management team’s, and employees’ interests and for everyone to have a collective investment in the company’s future.
- What is the share option?
The share option is a right to buy 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.
- How share option is beneficial both for the employer and the employee?
By offering employee share options, employers typically see increased loyalty, longer employment tenure, and more active participation in 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 is 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.
Joining a newly created start-up can be a very fulfilling but risky career move. For early-stage start-ups that in most cases offer share options, it is the only way to attract top talents as some time later a new company may not be able to offer a competitive salary. The company’s benefit, in this case, is also evident – the possibility to attract various specialists while preserving their loyalty, real involvement in activities, and motivation is highly ensured.
Share options are taxed as fringe benefits.
- Applicable taxes are paid by the employer.
- Applicable income tax and social security contributions - 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, which means that the taxable value is 1,500 EUR.
Law firm ECOVIS ProventusLaw has over 10 years of experience in labor and corporate law consulting, dispute resolution among shareholders, drafting shareholder options. If you are considering introducing an employee option scheme and realising employee retention and motivation benefits associated with it, do not hesitate and contact us for advice on how to best structure and duly implement such scheme.
The content of this article is intended to provide a general guide to the subject matter. The expert’s advice should be sought about your specific circumstances.
Prepared by an attorney at law Mrs. Loreta Andziulytė and senior associate Ms. Milda Šlekytė.