What are “stock options?”
Used in business settings, the stock option is a means of payment that generally pertains to senior managers and executives with an established career. This way of payment involves allotting workers shares of the company as a form of compensation.
In addition to affording the company ease in terms of salary -since it is not a money payment-, a sense of loyalty with the employee is generated. The acquisition of a shareholding package is dictated by special conditions previously established, and, as such, it increases the worker’s commitment to the company. Ultimately, and as with the contract of phantom shares, the stock options system embodies an additional compensation that aligns the objectives of the business with those of the employees.
As a general rule, stock options give the employee the right to buy shares from the company (call option) at a determined exercise price (strike) which generally will be lower than the market’s value (which could even be zero), and for a limited period of time (vesting period). In Spain, the use of stock options as an additional compensation has spread very quickly and has even replaced the traditional practice of salary payment in some cases.
Advantages of stock options
The main advantages that stock options offer are that:
- They establish a common objective between the company and the employee
- They create a win-win relationship: the better the performance of the company is, the better the reward for the employee
- They facilitate the retention of talent
- They do not immediately alter the liquidity of the company.
Benefits of stock options for workers
While this business payment model, a priori, can seem convoluted and complex, it is relatively simple in its application. As a general rule, the exercise of this purchase option that the employee has over the shares of the company is made effective when the exercise price of the stock options is lower than the market value of the company’s shares.
In this respect, the employee will buy company shares at a lower price than the real market value (which has been agree on by the company as an exercise price), and they will have the ability to later sell it at the real price determined by the market. The resulting difference from said sale will be the benefits that the employee obtains, without affecting the possible dividends that a company can distribute to its shareholders.
Fiscal aspects of Stock Options
The stock options system represents one of the alternatives for variable payments in the area of start-ups. Regarding the tax incidence which becomes detached from the practice of this payment system, we must fundamentally distinguish two specific points:
- The exercise of stock options and the consequent acquisition of the shares by the employee at price lower than market value
- The potential future sale of the shares.
According to the moment, the employee must be taxed for the income obtained (in the IRPF) either in terms of work income (first point) or in terms of capital gain (second point). In either case, the employee can benefit from certain tax exemptions, once certain requirements are met.
If you are planning to establish a plan for stock options in your company or further explore this or other additional payment systems for employees, do not hesitate to contact Mariscal & Abogados.
This article is not considered as legal advice