UK Law and Practice Contributed by: Dylan Doran Kennett, Michael Jacobs, Stephen Newby and Mark Ife, Herbert Smith Freehills LLP
A similar, but less flexible, tax-advantaged option scheme is the Company Share Option Plan (CSOP), which allows for options to be granted on up to GBP60,000 worth of shares. Unlike an EMI option, the option price must be set at least at market value, which can be agreed with HMRC, and tax benefits will only arise once the options have been held for at least three years, or are exercised early in certain “good leaver” or on certain change-of-control exit events. Given these restrictions, CSOPs are therefore generally only adopted once a company no longer quali - fies to grant EMIs. Companies may also consider replicating the benefits of an equity arrangement with a cash- based (or “phantom” ) share scheme. Under this type of arrangement, employees and ser - vice providers are granted the right to receive a cash payment from the company equivalent to the gain that they would have made on a share option. As there are no tax benefits to such arrangements, they are not restricted in struc - ture. As the company would need to fund the cash payments, for a venture-backed company awards will generally only vest and become pay - able on an exit event. Venture-backed companies may also make use of cash-based retention bonuses for key employ - ees, which will be paid following the individual remaining with the company for a specified peri - od of time, and potentially achieving certain key milestones within that period. There are no tax benefits available for cash-based arrangements. In addition to incentive arrangements, the com - mitment of key employees to the business will be procured through the terms on which they are employed, including through the length of the notice period that would need to be given in order to leave the employment (which will often
be coupled with the company’s ability to place a leaver on “garden leave” in order to protect the company’s confidential business informa - tion). Following cessation of employment, former employees will continue to owe obligations of confidentiality and may also be subject to cov - enants restricting them from joining a competing business, poaching employees or dealing with clients of the company for a period following departure. Any such restricted period runs con - currently with any period spent on garden leave. 5.2 Securities Usually, a founder’s ownership is earned, or vested, over time in order to incentivise them to commit and stay with their company. Reverse vesting is the most common in the UK, where a company will issue all of the equity to the founders upfront but subject to terms under which the company will “claw back” some or all those shares either by repurchase, transfer or conversion into deferred shares if the founder leaves before the end of a specified period. The vesting of the shares may also be subject to the achievement of milestones during the vest - ing period, which, if not achieved, will similarly result in a loss of the shares. One of the advan - tages of reverse vesting is that the founders, who often own most of the equity, get full voting rights attached to those shares from the point of issue. From the company’s perspective, reverse vesting protects the company against a situation where a founder leaves and takes all their shares with them. The company is free to set whichever vesting period and milestones it considers appropriate for the business. As the shares are subject to “forfeiture restrictions” , the founder will generally enter into “restricted securities election” with the company to ensure that any liability for income tax is limited to the point of acquisition, and not
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