Glossary for share schemes

📘 Overview

Share schemes can be a powerful way for companies to reward, retain and motivate employees, but the terminology can feel technical.

This glossary explains the key terms you’ll encounter, in plain English, with brief examples and context to help you understand how each concept fits into the overall process.

Overview: What This Covers

This guide explains the essential terms used in employee share schemes, including:

• ✅ How options are granted, vested and exercised
• 💡 What market value means and how it’s determined
• 📊 Common terms such as exercise price, vesting schedules and cliffs

🔑 Key Terms Explained

Grant of Option

This is the starting point of an employee share scheme.

A grant of option occurs when the company formally issues (or “grants”) the right to buy shares in the future.

• It usually happens through a signed option agreement, often executed as a deed.
• The grant does not give the employee shares immediately, it gives them the right to buy shares later under certain conditions.Example: If a company grants an employee 1,000 options at £2 per share, the employee can later choose to buy those shares for £2 each, even if the company’s value increases.

Vesting

Vesting is the process by which an employee gradually earns the right to exercise (use) their options over time.

• It’s a way to encourage long-term commitment.
• Vesting is typically tied to a time period or specific performance milestones.Example: If options vest over four years, the employee might gain access to 25 % of their total options each year.

Four Years’ Vesting with a One-Year Cliff

This is a common vesting schedule used in startups and growing businesses.

• Cliff period: During the first year, no options vest. If the employee leaves before the first anniversary, they lose all options.
• After the cliff: On the one-year anniversary the first 25% of options vest. The remaining 75% then vest gradually over the next three years (often monthly or quarterly).Example: If you have 1,200 options and a one-year cliff, you’ll receive 300 options after the first year, then 75 per quarter thereafter.

Exercise Price

The exercise price (also called the strike price) is the price per share that the employee must pay to convert their options into actual shares.

• It’s usually set at the market value of the shares at the time the option is granted.
• This price remains fixed even if the company’s value later rises.Example: If your exercise price is £1 and the company’s shares later rise to £5, you can buy at £1, a substantial potential gain.

• Exercise of Option

  Exercising an option means the employee has decided to buy their shares at the agreed exercise price.

  • Upon payment, the employee becomes a shareholder and gains ownership rights.
  • Depending on the scheme, tax obligations (such as income tax or capital gains tax) may apply at this stage.Example: You hold 1,000 options at an exercise price of £2. When you exercise, you pay £2,000 and receive 1,000 shares in the company.

Market Value

The market value represents how much the company, or an individual share, is worth at a particular time.

• For tax-advantaged schemes this value is often **agreed with HM Revenue & Customs (HMRC) in advance.
• In other cases, it might be determined by a third-party valuation or based on recent investment rounds.
• Market value fluctuates as the business grows or its circumstances change.Important: Different stakeholders (founders, investors or HMRC) may view value differently depending on their goals and assumptions.Example: Investors may value a company higher based on growth potential, while HMRC may take a more conservative approach when assessing tax liability.

Share Option

A share option is the right (not obligation) to buy a share in the company at a fixed price in the future.

• It is not the same as owning a share, ownership only arises once the option is exercised.
• Options are a flexible tool for rewarding employees without issuing shares immediately.

💡 Practical Points

• A grant gives rights, not shares.
• Vesting defines when those rights can be used.
• Exercise converts rights into shares, at the exercise price.
• Market value affects both pricing and tax treatment.
• Recent guidance: If you are in an approved scheme (e.g., EMI, CSOP), you may not pay income tax or National Insurance on the exercise if conditions are met.
• Also important: You must submit annual returns for employment related securities.

• ✅ Summary

  Understanding these terms helps you make sense of how share schemes work in practice.

  They define when you gain rights, how you can use them and what they might be worth.

  If you’re unsure about your own share options or need to check valuation details, see the 🔗 HMRC guidance on employee share schemes for official information.