What are the advantages and disadvantages for companies to grant employees stock options?

Employee share schemes: advantages for employees

Employee share schemes enable staff to benefit from the business success they're helping to create.

Share options pose no financial risk - if the market value is less than the exercise price, employees don't have to exercise the option.

Employee share schemes: disadvantages for employees

However, there are some disadvantages for employees, such as:

• Share values could drop - risking losing the value of their shares if the business runs into difficulty, which increases their financial dependence on the business.
• Lower salary - sometimes being expected to take a lower salary in return for receiving shares.
• Qualifying period of service - having to stay with the company for a certain period to qualify for shares. This may tie employees to a job they would otherwise leave and may affect both their own morale and productivity and those of other workers.
• Repaying tax on shares - leaving before the period specified in the share plan means employees lose any options/shares and may have to repay National Insurance contributions (NICs) and income tax relief.
• Tax payments on unapproved share schemes - having to pay income tax and NICs when they acquire shares in a taxed (unapproved) share scheme even if they haven't got enough money to do so without selling some or all of the shares. In addition employees of private companies may not be able to sell the shares easily to raise the money.
• Restrictions - having to pay income tax and NICs each time a restriction is changed or removed if their shares are in an unapproved share scheme which carries certain restrictions.

Tax advantages for HMRC approved share schemes

Employees participating in tax-advantaged share schemes - ie those approved by HM Revenue & Customs (HMRC) - don't pay income tax or NICs when they acquire the shares.

Under a share incentive plan there is no Capital Gains Tax as long as the employee sells their shares as soon as they are removed from the plan - see HMRC approved share schemes.

Dividends on plan shares may be reinvested tax-free in further plan shares.

1. Stock options benefit both employees and employers. Along with two basic types of option plans (incentive stock options and nonqualified option plans), there is flexibility in constructing plan contents. Although available primarily to company senior executives, stock option plans now often exist for many other employee groups. Formerly the purview of larger companies, small business is now also deriving benefits from offering stock options. Businesses receive three primary valuable benefits.

Employee Stock Options Explained

1. A stock option is an offer by a company that gives employees the right to buy a specified number of shares in the company at an agreed upon price (usually lower than market) by a specific date. The employee is under no obligation to purchase all or part of the number of shares noted in the option. The choice is theirs alone and they can normally purchase stock at any point during the time period between the offer and last exercise date.

Attract and Keep Talented Employees

1. Most companies are painfully aware of the difficulty in attracting talented staff. Just as successful sports teams must “grow” their own talent or attract experienced players from other teams, employers must follow the same path. Top recruiting firms, like Kelly Services and others, and extensive company sponsored searches seek the best available talent, even during down economies. Offering meaningful stock options both attracts better, more talented employees and helps keep them for the long term.

Create More Dedicated Employees

1. Employers are constantly attempting to motivate employees and generate loyalty. Volumes have been written about the subject, and numerous “experts” and consultants abound with a wide variety of theories, suggestions and programs. Stock options are a valuable benefit that companies use to create higher level motivation and dedication. It typically works very well, reports Laurie Collier Hillstrom in her article "Employee Stock Options and Ownership (ESOP)." As employees exercise stock options, they usually become more committed to a company’s success. Their stock value hinges on company performance, which, of course, is a direct by-product of employee achievement. Historically, stock options create motivation and dedication for all employees involved as they are more invested in the company and its results.

Cost Effective Company Benefit

1. As the cost of all employee benefits continues to increase, companies expand their search for programs that offer high value for moderate cost. Stock option plans often prove to be a strong benefit for employees and cost-effective for companies. While stock options are seldom substitutes for compensation increases, as part of a solid benefit program, they help make employment packages more attractive. The only significant costs to the company are the lost opportunities to sell some stock at market value (since employees usually buy at a discounted rate) and the expense of administering the plan. Added to the ability to attract, keep and motivate staff, the cost efficiency of stock options helps many smaller companies compete with larger organizations by offering comparable benefit programs.

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