Employee share schemes are a popular way for businesses to attract, retain and incentivise key employees – particularly in founder-led companies, start-ups and growth businesses. While the underlying idea is simple, the design of an employee share scheme can be complex. Getting the structure right is critical to ensure the scheme works commercially, aligns incentives, and delivers the intended tax outcomes for both the company and its employees.
What is an employee share scheme?
An employee share scheme allows select employees to acquire an ownership interest in the company as part of their remuneration package. In practice, schemes can be structured in a number of ways, depending on the company’s objectives, the employee’s role, and tax considerations. There is no one-size-fits-all approach.
Why have an employee share scheme?
Employee share schemes give key employees a genuine stake in the success of the business, aligning their interests with those of founders and existing shareholders. They are particularly common in start-ups and growth companies, where cash-flow may be constrained. In these businesses, equity can form part of a competitive remuneration package without placing immediate pressure on salary budgets.
How to structure an employee share scheme
Shares and options
Under an employee share scheme, an employee may either:
• receive shares in the company (an Employee Share Scheme, or ESS); or
• receive options to acquire shares in the future (an Employee Share Option Plan, or ESOP).
Although technically different, both structures are commonly referred to as employee share schemes.
Vesting and exercise
Vesting determines when an employee becomes entitled to the shares or options granted under the scheme. For shares, vesting means the employee becomes the legal owner of the shares and receives the benefits attached to them. For options, vesting means the employee may exercise the option and acquire shares.
Vesting often occurs over time — commonly between 6 months and 5 years — to encourage employee retention. In some ESOPs, options only vest on a liquidity event, such as a company sale, major restructure or public listing.
In these cases, the employee typically receives the difference between the option exercise price and the value of the shares at the liquidity event, without needing to fund the purchase price upfront.
Rights attaching to shares
Once shares have vested (or options have been exercised), the employee becomes a shareholder. However, employee shareholders do not always hold the same rights as other shareholders. Many schemes limit employee rights to receiving dividends, without voting or governance rights. This allows businesses to share financial upside while retaining control.
Purchase price
Under an ESS, an employee may acquire shares for no cost, or may pay for them at vesting — often at a discounted price. Under an ESOP, employees typically pay nothing when the option vests and instead pay the exercise price if and when they choose to acquire the shares.
Tax treatment
Tax is a key consideration when designing an employee share scheme. Under an ESS, tax is generally payable when the shares vest. Under an ESOP, tax is typically payable when the option is exercised (not when it vests).
In both cases, tax is calculated on the difference between the market value of the shares and the price paid by the employee.
From 1 April 2026, new tax rules will apply, allowing private companies to defer tax on employee shares or options until the earliest liquidity event. This change is expected to significantly improve the cash-flow impact of employee share schemes and may prompt many businesses to review or implement schemes.
What happens when an employee leaves?
Employee share schemes are usually designed on the assumption that equity rewards long-term contribution. Unvested shares or unexercised options typically lapse when an employee leaves the business. Where an employee already holds shares, schemes usually require those shares to be sold back to the company or other shareholders.
Clear exit provisions are essential and should address:
• what happens to unvested shares or options;
• whether shares must be sold on exit; and
• how the sale price is determined.
To avoid costly valuations, many schemes include a simple pricing formula to provide certainty and predictability for both parties.
WANT TO LEARN MORE?
Get in touch with our commercial team here, or by contacting:
– Natalie Smith – Partner
– Nick Bielby – Senior Solicitor
