Option Agreement For Shares: Founder Checklist

Are you ready to give someone options, but not quite sure what needs to go on paper first? Yes, you can grant options in a startup, but you should document the arrangement carefully before anyone starts relying on it.

An option agreement for shares gives someone the right to buy shares later, usually if they stay with your business or hit certain milestones. It can be a brilliant way to reward early employees, advisors and contractors without handing over shares straight away.

The tricky part is that options sit right at the intersection of company law, employment, tax and your cap table. The good news is that this doesn't have to be complicated if you work through the key terms before you issue anything.

What Is An Option Agreement For Shares?

An option agreement for shares is a written agreement that gives someone the right, but not the obligation, to buy shares in your company in the future.

For a UK private company limited by shares, this usually means your company grants options over ordinary shares, subject to conditions. The person receiving the option doesn't usually become a shareholder on day one. They only become a shareholder if they exercise the option and the company issues or transfers shares to them.

Options are popular because they let you reward people for helping build the business while keeping control of the shares until later. For example, you might use options for:

• Employees who are joining early and accepting a lower salary than they could earn elsewhere.
• Advisors who are giving strategic support over several months or years.
• Contractors who are delivering key work, such as product development or design.
• Senior hires who you want to retain through a growth period or funding round.

A startup option agreement usually sits alongside your articles of association, shareholders agreement, board approvals and any employee share option plan rules. If those documents don't line up, you can end up with confusion about who has rights, when shares can be issued and what happens when someone leaves.

Templates can be a useful starting point, but option documents work best when they're tailored to your company, your share structure and the commercial deal you've actually agreed.

Do You Need A Share Option Agreement In The UK?

Yes, if you're giving someone a right to buy shares later, you should have a written share option agreement in place before the grant is treated as agreed.

A casual email saying someone will get 1% equity can create real problems. Does that mean 1% now, or 1% after the next investment round? Is it a right to shares or just an intention to discuss shares later? Do they get anything if they leave after three months?

A written agreement helps you avoid those arguments because it sets out the rules clearly. It also helps you show investors that your cap table is tidy and that any promised equity has been properly approved.

In England and Wales, you should think about the Companies Act 2006, your company's articles, any shareholders agreement and any restrictions on issuing shares. If options are being granted to employees, you'll also want to make sure the terms sit neatly with their employment contract and any relevant policies.

If you're using an Enterprise Management Incentive scheme, often called EMI, there are extra HMRC rules. EMI can be very attractive for qualifying companies and employees, but the conditions are technical. Broadly, EMI is aimed at smaller qualifying trading companies. For most eligible companies, the current EMI limits include gross assets of £120 million or less, fewer than 500 full-time employees, a £250,000 individual limit and a £6 million total unexercised EMI limit. Different or lower limits can apply for certain Northern Ireland companies, so you should check eligibility before granting options or promising EMI treatment.

For contractors and advisors, EMI usually won't be available because they aren't employees. That doesn't mean you can't grant options to them, but the tax and documentation may look different.

What Should You Include In A Share Option Agreement?

You should include the commercial deal, the vesting rules, what happens when the person leaves, how the option can be exercised and the company approvals needed to make the grant valid.

Here is a practical fill-in outline you can use to brief your lawyer. This isn't a finished legal document, and it should be tailored before you use it.

1. Parties - name the company and the option holder, using the correct legal names and addresses.
2. Grant Date - state the date the option is granted, which should match your board approval.
3. Number Of Options - set out the exact number of shares under option, not just a percentage.
4. Share Class - describe the class of shares, such as ordinary shares, and check the rights attached to them.
5. Exercise Price - state the price payable for each share when the option is exercised.
6. Vesting Schedule - explain when options become exercisable, such as monthly over four years with a one-year cliff.
7. Performance Milestones - include any targets that must be met before options vest, such as product launch or revenue milestones.
8. Exercise Process - explain how the option holder gives notice, pays the exercise price and signs any required documents.
9. Expiry Date - set the final date by which the option must be exercised, such as 10 years from grant.
10. Leaver Rules - set out what happens if the option holder resigns, is dismissed, completes the project or breaches the agreement.
11. Restrictions After Exercise - require the option holder to sign a deed of adherence to your shareholders agreement before receiving shares.
12. Tax And Scheme Rules - refer to EMI or non-tax-advantaged treatment where relevant, and make clear who is responsible for tax.
13. Company Approvals - record that the grant depends on any board, shareholder or investor approvals required by your company documents.
14. Confidentiality - protect sensitive commercial terms, especially where different team members have different equity packages.
15. Governing Law - choose the law that applies, usually England and Wales for a UK company based there.

Try to use numbers wherever possible. A promise of 0.5% can become misleading after investment, option pool increases or share splits. A fixed number of options is usually clearer, with separate explanation if you want to show the approximate percentage at the grant date.

How Do Vesting, Exercise Price And Leaver Rules Work?

It depends on the deal you're offering, but vesting, exercise price and leaver rules are the three terms that usually create the biggest practical consequences.

Vesting

Vesting, often set out in share vesting rules, decides when the option holder earns the right to exercise options. A common startup approach is vesting over four years with a one-year cliff. This means nothing vests if they leave before the first anniversary, then part of the options vest at 12 months, with the rest vesting monthly or quarterly after that.

Say Priya runs a SaaS startup in Manchester. She grants her first senior developer 10,000 options over ordinary shares, vesting over four years with a one-year cliff. The exercise price is 10p per share.

After 18 months, the developer has vested 18 out of 48 months, which is 37.5% of the grant. That means 3,750 options have vested. If the agreement lets the developer exercise vested options when leaving, the exercise cost would be 3,750 x 10p, so £375.

Exercise Price

The exercise price is what the option holder pays for each share when they exercise. Under an EMI scheme, you may want to agree a market value with HMRC before granting the options, because this can affect the tax treatment. For non-EMI options, you should still be clear about the price and get tax input where needed.

Leaver Rules

Leaver rules decide what happens if the person stops working with you or stops providing services. You might decide that:

• Unvested options lapse immediately when they leave.
• Vested options can be exercised within a set period, such as 90 days, after leaving.
• Options lapse if the person is dismissed for gross misconduct, breaches confidentiality or joins a competitor.
• Special rules apply on death, serious illness, redundancy, a share sale or a sale of the company.

These rules should be drafted carefully, especially for employees. You don't want your option terms to cut across employment rights under the Employment Rights Act 1996 or create avoidable disputes around dismissal or resignation.

What Company Approvals Do You Need Before Issuing Options?

You usually need board approval, and you may also need shareholder approval depending on your articles, shareholders agreement and any investor rights.

Before granting options, check who has the power to approve them. In many startups, the directors can approve a grant within an agreed option pool. In others, major shareholders or investors have consent rights over any new option issue.

You should also check the company's authority to grant options and issue shares. Because an option can be a right to subscribe for shares, statutory and contractual pre-emption rights and directors' authority to allot may need to be dealt with at the grant stage, not just on exercise. Then, when the option is exercised, you should check again that the company can allot the shares and that any pre-emption rights have been disapplied, waived or don't apply.

A practical approvals checklist looks like this:

• Articles Of Association - do they allow the share class and the issue process you're planning?
• Shareholders Agreement - are there investor consents, option pool limits or transfer restrictions?
• Existing Cap Table - have you counted fully diluted shares, including all existing options and warrants?
• Board Minutes - have the directors approved the grant and recorded the key terms?
• Shareholder Resolutions - do you need authority to allot shares or to disapply or waive pre-emption rights at grant or exercise?
• Option Plan Rules - does the grant fit within the rules of your employee share option agreement or wider scheme?
• Deed Of Adherence - will the option holder need to join the shareholders agreement when they exercise?

Companies House usually doesn't need a filing just because options are granted. The filing point normally comes when shares are actually allotted on exercise. A return of allotment, form SH01, must be filed at Companies House within one month of the allotment. You should also update the company's register of members and check whether any person with significant control records are affected.

For EMI options, HMRC notification rules are separate. EMI options must generally be notified to HMRC by 6 July after the end of the tax year in which the grant was made, and annual Employment Related Securities returns are also due by 6 July. Missing these steps can damage the tax treatment, so it's worth diarising them at the grant stage.

What Changes For Employees, Advisors And Contractors?

The main terms can look similar, but the legal and tax position changes depending on whether the option holder is an employee, advisor or contractor.

For employees, the option agreement should sit alongside the employment contract. It should make clear that options aren't wages, don't guarantee ongoing employment and don't replace any statutory rights. If options are linked to performance or continued employment, be careful that the criteria are objective and consistently applied.

You should also think about discrimination risks. For example, if vesting stops during maternity leave or long-term sickness in a way that disadvantages someone, that may create problems under employment law. ACAS guidance is useful when you're dealing with workplace policies and fair treatment, but option terms often need more tailored drafting.

For advisors, you may want milestone-based vesting rather than time-based vesting. If an advisor is helping you raise investment, introduce customers or shape the product roadmap, spell out what they actually need to do. A vague promise of advisor options can be hard to manage later.

For contractors, keep the option agreement consistent with the contractor agreement. If you say too much about control, hours or integration into the team, you may create mixed signals about employment status. The option documents should support the commercial reality, not rewrite it accidentally.

Across all three groups, protect your intellectual property and confidential information. If someone is receiving options because they're creating code, designs, brand assets, customer lists or product strategy, make sure your IP assignment and confidentiality terms are already in place. The UK IPO won't fix ownership gaps in your contracts for you.

Common Mistakes To Avoid

The most common mistake is promising equity before you've checked the cap table, approvals and tax position.

Here are the issues we see founders run into most often:

• Promising Percentages Instead Of Numbers - saying someone gets 1% can become unclear after a funding round or option pool increase. Use a number of options and explain dilution separately if needed.
• Forgetting Investor Consent Rights - your shareholders agreement may require investor approval before you grant options, even if the board is supportive.
• No Leaver Rules - without clear leaver rules, someone who leaves early may still argue they kept valuable rights.
• Using The Same Terms For Everyone - employees, advisors and contractors often need different vesting, exercise and tax wording.
• Missing EMI Admin - if you're relying on EMI treatment, late HMRC notifications or incorrect valuations can create expensive surprises.
• Skipping The Shareholders Agreement - if an option holder exercises and becomes a shareholder, they should usually be bound by the same transfer restrictions, confidentiality terms and drag-along rules as other shareholders.
• Not Explaining Dilution - options can become sensitive if the holder doesn't understand that their percentage may reduce as the company raises capital.

A simple way to stay organised is to keep an option register alongside your cap table. Record the grant date, option holder, number of options, share class, exercise price, vesting start date, vested amount, lapses and exercises. This makes due diligence much easier when you're raising investment or selling the company.

If something has already gone wrong, start by collecting the documents and messages: offer letters, board minutes, emails, cap table versions and any draft agreements. Then avoid making fresh promises until you've worked out what was actually agreed and what approvals were in place.

Key Takeaways

• An option agreement for shares gives someone a right to buy shares later, not an automatic shareholding on day one.
• Your agreement should cover the number of options, share class, exercise price, vesting, expiry, leaver rules and exercise process.
• Check your articles, shareholders agreement, board approvals, authority to allot and pre-emption rights before granting options and again before shares are issued.
• EMI can be valuable, but eligibility limits and HMRC deadlines need careful checking, especially for Northern Ireland companies.
• Employee, advisor and contractor options can need different terms, especially around EMI eligibility, milestones and employment status.
• Clear documents now can save you from messy cap table disputes when you raise investment or sell the company.

If you'd like help with share option agreements, EMI eligibility, company approvals or cap table documents, you can reach us at 08081347754 or team@sprintlaw.co.uk for a free, no-obligations chat.