US Trends Offer Guide to UK Companies Granting Share Options (1)

For companies looking to reward employees with equity, share options are a popular choice: they’re generally straightforward, potentially tax efficient, and focus employees on company performance.

With the increasing mobility of global talent, and a growing trend of UK companies pursuing US listings, there are indications that UK share option conventions are steadily moving towards US norms.

This makes it more crucial than ever for UK companies to consider share option trends across the Atlantic. In both jurisdictions, companies can grant:

• Tax-advantaged options (providing favorable capital tax treatment for option holders if certain conditions are met)
• Options that don’t confer tax advantages (meaning that the employment/income tax rules apply).

In the UK, the main tax-advantaged options are Enterprise Management Incentives and Company Share Option Plans—the latter usually implemented by companies that don’t meet the Enterprise Management Incentive criteria.

In the US, Incentive Stock Options offer potential tax advantages. Options that don’t offer favorable tax treatment are sometimes referred to as “unapproved” options in the UK and non-qualifying stock options in the US.

Grant Recipients

In both jurisdictions, it’s possible to grant options to a range of service providers, including employees, non-executives, consultants and advisers, although the tax treatment can differ between the categories of option holders.

In the UK, certain company law and regulatory relaxations apply to share option plans that limit participation to employees only. For this reason, it’s common for companies to create two UK plans: one for employees, to which the relaxations apply, and one for consultants and advisers.

In contrast, in the US it’s common to see a single plan used to award options to any person providing services to the company.

Valuation Contrast

A crucial difference between US and UK employee share plans is the role that the valuation plays in determining the exercise price of an option.

Material adverse tax consequences can arise in the US if either an incentive stock option or a non-qualifying stock option has an exercise price other than the fair market value of the option stock at the date of grant.

The US Internal Revenue Code, which governs how companies must price options to avoid adverse tax consequences, requires a “409A valuation” (named after the relevant section of the tax code) to evidence a fair market value exercise price.

Although a valuation has a role to play in a UK tax-advantaged option plan, it’s not required for a UK unapproved option. In general, the UK valuation process and methodologies are less onerous and often result in lower option exercise prices being achievable in the UK compared to the US.

Leaver Provisions

Equity isn’t just useful for attracting talent; it’s crucial for retention. Well-drafted good and bad leaver provisions are necessary to achieve this objective.  Historically, quite a different approach was taken to the treatment of leavers in the US and the UK.

In the UK, only leavers falling within a narrowly defined range of “good” circumstances, such as those leaving due to disability or retiring at normal retirement age, were typically entitled to retain any benefit from their option on leaving.

US plans, by contrast, generally treat an individual as a good leaver unless their employment terminates for “cause”—misconduct or similar behavior.

Sectors with strong UK-US overlap are shifting UK practices toward the more employee-friendly US standard.

Exercise Triggers

“Exit only” option plans—under which options can only be exercised on the occurrence of a share sale, initial public offering or similar liquidity event—are common in the UK.

However, they are rare in the US, where it’s typical to allow options to be exercised after a specified time-based vesting period is satisfied. Staggered vesting of an option over three or four years is common.

The ability to exercise a US option in advance of an exit event is critical for incentive stock option tax advantages, because to benefit from capital tax treatment, shares must be held for a minimum of one year after exercise of the option before the shares are sold.

‘Double Trigger’ Vesting

Some option plans accelerate vesting of awards on a change-of-control event so that, irrespective of how far into the vesting timeline an individual is when a company sale occurs, the full value from their option can be realized.

However, full acceleration is often viewed as overly generous, particularly for new starters who join shortly before a sale.

Where accelerated vesting isn’t adopted, the norm in the UK is that the unvested proportion of an option simply lapses a short time after the change of control event. Purchasers of UK companies expect to acquire 100% of the share capital of a company without having to deal with lingering option entitlements.

In the US, it’s more common that option plans continue, or roll over into a purchaser’s incentive plan, after a change of control. As a result, the concept of “double trigger” vesting is well understood in the US.

This provides that vesting will accelerate if two distinct events occur: a change of control and a subsequent termination of the option holder’s employment, usually without cause and within six months to a year of the control change.

Such provisions protect employees from losing the value of their option if they aren’t retained by the new owner.

The UK approach that compels options to be either exercised or lapse shortly after an acquisition makes replicating double trigger mechanisms difficult in UK companies: careful thought is needed before promising double trigger vesting terms to participants.

An Important Tool

A transatlantic share option plan can be a crucial tool to incentivize and retain talent.

Being aware of the discrepancies between US and UK market norms,—particularly on key points such as exercise triggers, exercise price, leaver provisions and vesting—will ensure thoughtful framework design from the outset. This in turn increases the likelihood that a plan will be suitable for grants in both jurisdictions for the long term.

It has been a turbulent time for tax reform in the US in recent months, and it remains to be seen whether there will be further adaptations to the executive compensation landscape. Staying attuned to this, as well as existing US incentive practices, also provides valuable insight into the future direction of employee incentives in the UK, given the heavy US influence on the UK market.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Julia Cockroft is a tax partner with Bristows.

Lucy Urwin is a senior tax associate with Bristows.

Tabitha Reed is a tax associate with Bristows.

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