Company Share Option Plans

A company share option plan (“CSOP”) is an employee benefit scheme that grants employees the right to purchase a certain number of shares in the company at a pre-determined price.

CSOPs align the interests of employees with those of the company’s shareholders by giving employees a direct interest in the company’s success via their shareholding.

How a CSOP Works

1. Eligibility and Criteria: The company determines the eligibility criteria as to which employees or full-time directors can participate in the scheme.
2. Grant of Options: Employees are granted options to buy shares at a specific price, known as the exercise price. This exercise price cannot be lower than the market value of the shares on the grant date. HMRC suggests that the market value should be agreed with them in advance where the shares relate to a private company.  An individual can only hold a maximum of £60,000 of unexercised CSOP options.
3. Vesting Period: There is often a vesting period, which is a set amount of time that must pass before employees can exercise their options. This period can vary and the only statutory requirement is that any options must not be capable of exercise more than 12 months after the death of the option holder. In order to obtain tax-advantages, except in certain prescribed circumstances, the options must not be exercised before the third anniversary of the date of grant, nor after ten years from the grant date.
4. Exercise of Options: After the vesting period, employees can choose to exercise their options, meaning they can buy the shares at the exercise price regardless of the current market price. If the market price is higher than the exercise price, employees can benefit from the difference.
5. Selling the Shares: Once employees have purchased the shares, they can choose to hold onto them or sell them, subject to restrictions in the articles of association of the company and/or any shareholders’ agreement to which they are a party. If they sell them at a price higher than the exercise price, they realise a profit.

Benefits of a CSOP

1. Employee Motivation: By tying part of their compensation to the company’s share performance, employees may feel more motivated to contribute to the company’s success. When the company performs well, the share price typically rises, benefiting employees who hold options.
2. Retention: The vesting period encourages employees to stay with the company longer, reducing turnover. Employees are more likely to stay until they can exercise their options and realise their value.
3. Tax Advantages: In the UK, CSOPs can offer tax advantages to both the employer and employees if certain criteria are met.
4. Alignment of Interests: Share option plans align the interests of employees with those of shareholders, as everyone benefits from an increase in the company’s share price.
5. Risk free: As is the case with any share option, there is no initial financial cost or obligation on participating employees with a CSOP option.

Potential Risks and Considerations

1. Share Price Volatility: The value of the options is tied to the company's share price, which can be volatile. If the share price falls below the exercise price, the options become worthless.
2. Dilution: Issuing new shares to employees can dilute the ownership percentage of existing shareholders. This is a consideration for the company when designing the plan.
3. Complexity: CSOPs can be complex to administer and understand. Employees need to be educated on how the options work and the potential risks and rewards.
4. Limit on value of options: Each individual can only hold options up to £60,000 in value on grant. Whilst they can benefit from the growth on these shares, that may limit the benefits that the individual may achieve.

A CSOP is a useful tool for motivating and retaining employees by providing them with a share in the company’s future success.  While there are risks associated with share price volatility and dilution, the potential benefits in terms of employee engagement and alignment with shareholder interests can make CSOPs an attractive component of a company’s remuneration strategy.