Key Pillars of Equity

There are different types of equity schemes, and the type of equity you own has implications for when you become a shareholder and potentially how much your equity is worth. The key question most employees ask themselves is: when does my equity stake turn into actual shares in the company? Stock options are different from shares - they simply represent the right to buy shares in the company at a point in the future, usually at a discount rate. The discount rate is typically the strike or exercise price compared to the market value of the stock at the time of the option grant. To differentiate between the two types of equity, let’s first look at the example of two equity types - stock options and RSUs (Restricted Stock Units, an example of stock) - the two principal types of equity you might have in a private company:

Type 1 - Options‍

An option grant gives the holder the right – but not the obligation – to buy company stock (shares) at a set price (called the strike or exercise price), at a certain date (commonly called the exercise date) after some or all of the options have vested. In this case, after the purchase (known as exercising), you become a shareholder of the company.

With an option plan, your equity portfolio will then consist of:

• Unvested stock options. These are not yet “exercisable”, which means you haven’t earned the right to buy them from your employer and convert them into actual shares.
• Vested but unexercised stock options, i.e. options that you can exercise as soon as your company opens the next exercise window. Exercise windows are usually announced by companies well in advance, so that you don’t miss the opportunity and evaluate your readiness to invest in exercising.
• Actual shares, i.e. exercised stock options. Once you’ve exercised share options, you become an actual shareholder in the company.

A special case in stock options is Virtual Share Option Plan (VSOP), which is a type of employee participation plan that distributes virtual shares to team members. Virtual shares are not designed to give you an ownership stake in the company: they simply represent your right to benefit from the cash value of your virtual shares when a cash event occurs, which usually is the case when the company sells or lists publicly.

Ledgy’s interface offers you a full overview of your current portfolio and vesting schedules for the grants you are holding.

In the Ledgy's dashboard you get the details of your stake. You can see both the numerical amount as well as the grant’s estimated value, and the details on the vested/unvested grants and the cost to exercise.

If you hold not only options, but also actual shares (through exercising or investing) you can check the specific quantities.

Type 2 - RSUs

When you are granted stocks directly, you don’t have to exercise them. With RSUs, for example, you become a shareholder in the company automatically once certain conditions are met – these could be performance-related or related to your tenure with the company.

This type of equity can be subject to a number of restrictions (hence the name) on how and when you receive the stock - for example, your personal performance evaluated during company review cycles might determine the number of RSUs you will be getting, or company performance, current market conditions, current company valuation might determine if stock is granted to the employees.

When you know which kind of scheme you’re being offered, you can better understand future tax obligations and other restrictions.

The information provided in this guide is for educational and informational purposes only and should not be construed as financial or strategic advice. Any decisions regarding equity, accounting, investments, or business strategies should be made after consulting with qualified professionals or specialists in the field.

Equity incentive plans can take various forms. Let’s explore the most common equity compensation methods:

Employee Stock Ownership Plan (ESOPs)

How they work: Stock options grant employees the right to purchase a specific number of company shares at a predetermined price (the exercise or strike price) at a future date.

Where you mostly find them: Common across Europe

Explore: deep-dive blog and ESOP guide

Phantom Stock Options Plan (PSOPs) and Virtual Stock Options Plan (VSOPs)

How they work: A phantom or virtual plan gives employees the economic benefit of stock ownership without giving them the company stock. It follows the share price, but doesn't give you the same rights as holding a share. Employees receive hypothetical units that track the company's stock price. You will benefit from a potential upside (i.e. the difference between market value and strike price) after a pre-defined cash event (usually when a company goes public or is sold) takes place. Employees receive cash or equivalent based on the increase in the stock's value. Unlike other stock options plans, Phantoms are settled with the employer and not exercised.

Where you mostly find them: Germany

Explore: PSOP deep-dive blog post and VSOP guide

Company Share Option Plan (CSOPs)

How they work: CSOPs are designed to incentivise and reward employees by granting them the option to purchase shares in their employing company at a predetermined price (the exercise or strike price) in the future. CSOPs are similar to ESOPs, however are different in the tax treatment they offer to employees.

Where you mostly find them: UK

Warrants

How they work: Very similar to options, warrants can be exercised and it converts to a real share. The difference is that sometimes they have a purchase price, meaning you have to pay to even get a warrant and then later on pay the strike price attached to it to get the real shares. In the US, warrants can commonly be exercised after vesting at any time before the expiration date, whereas in Europe it is more common that warrants are only exercised on the expiration date.

Where you mostly find them: Common across Europe

Explore: deep-dive blog post

Restricted Stock Units (RSUs)

How they work: RSUs are actual shares of stock granted to employees, but they are subject to a vesting schedule and other conditions that may vary (these might be related to performance or tenure, for example). Once vested, employees receive the shares.

Where you mostly find them: USA, later-stage growing companies in Europe

Explore: deep-dive blog post

Growth Shares

How they work: Also known as ‘hurdle shares’, in a growth share scheme, your share price has to clear a hurdle set by the board before employees can see any value from their shares. If you are being enrolled in a growth share scheme, it’s critical to understand the current price per share and the hurdle price, so you can plan when you’ll see a return from your share ownership.

Where you mostly find them: UK

Explore: deep-dive blog post

Enterprise Management Incentive Scheme (EMI)

How they work: EMI plans provide a way for employees to acquire shares in the company they work for, often at a predetermined price, which can be below the market value. Under an EMI plan, eligible employees are granted share options, which give them the right to purchase company shares at a specified price (the exercise price) in the future. The exercise price is often set at the market value of the shares at the grant date.

Where you mostly find them: UK

Explore: deep-dive blog post

Share Incentive Plans (SIP)

How they work: SIPs are commonly used by companies in the United Kingdom as a form of tax-advantaged employee ownership. Employees can contribute a portion of their pre-tax salary to the SIP. These contributions are used to purchase shares in the company. In addition to employee contributions, some SIPs also allow the company to make contributions on behalf of employees. SIPs may have eligibility criteria, such as a minimum period of service before employees can participate fully in the plan.

Where you mostly find them: UK

Explore: deep-dive blog post

Long-term Incentive Plans (LTIP)

How they work: LTIPs are designed to reward executives and key employees for achieving long-term strategic goals. These plans often include stock options, restricted stock, or performance-based awards.

Where you mostly find them: Common across Europe and globally

Explore: deep-dive blog post

PAYE and SAYE

How they work: The SAYE (Save as you Earn) equity plan is designed to encourage employees to save money over a fixed period, usually three, five, or seven years, with the option to use those savings to purchase shares in the company at a discounted price at the end of the savings period. Employees participating in a SAYE plan make regular contributions from their pre-tax salary to a savings account. These contributions are usually made through payroll deductions. PAYE (pay as you earn) equity refer to programs where employees participate in an equity plan, such as a share incentive plan or stock option plan, and any tax liability associated with the equity awards is managed through the PAYE tax withholding system.

Where you mostly find them: UK

SARs

How they work: Stock Appreciation Rights (SARs) are a type of employee compensation that is settled in cash or (less frequently) in stock. SARs offer the rights to receive proceeds from the stock price increases without having to pay the strike price. Upon exercise, the employee will receive the difference between the current fair market value and the strike price (usually fair market value on the grant date). Often, SARs will be issued "in tandem" with the stock options to help employees pay the strike price for the stock options.

Where you mostly find them: Netherlands, USA

BSPCE

How they work: Bons de souscription de parts de créateur d’entreprise (BSPCE) are a special category of stock options, used by companies based in France. Companies eligible to give BSPCE need to be incorporated less than 15 years ago, have a valuation lower than €150 million and be privately held by individuals with a minimum shareholding of 25%. BSPCE benefit from a favorable social and income tax treatment. If the beneficiary stays in the company for a certain time period, they are entitled to a reduced flat tax treatment.

Where you mostly find them: France

Explore: BSPCE deep-dive guide

Performance Share Units

How they work: PSUs are a type of stock option plan where employees receive options based on the company's performance goals or milestones, such as financial targets (e.g., revenue, earnings per share), operational goals (e.g., market share, customer satisfaction), or other key performance indicators (KPIs) relevant to the company's strategy. The value of the options depends on achieving specific performance targets. When employees are awarded PSUs, they do not immediately receive actual shares of stock. Instead, they receive a promise to receive a specified number of shares or a cash equivalent at a future date if performance criteria are met.

Where you mostly find them: USA, later stage growing companies in Europe

Employee Stock Purchase Plans (ESPPs)

How they work: ESPPs allow employees to purchase company stock at a discount, often through payroll deductions. Employees can acquire shares at a discount, potentially benefiting from immediate gains.

Where you mostly find them: USA, later-stage growing companies in Europe

Explore: deep-dive blog post

Useful materials to deepen your knowledge:

Enterprise Management Incentive (EMI) Schemes: The Startup Guide | Ledgy

Growth shares 101: 'Need-to-knows' for UK startups | Ledgy

Employee Stock Purchase Plan (ESPP) 101

Stock Warrants vs Options: Breaking Down the Differences

Share Incentive Plans (SIPs): What Are They & How Do They Work?

Phantom Stock Plans: What Are They, And How Do They Work? | Ledgy | Ledgy

Employee Stock Ownership Plan (ESOP): The Ultimate Guide | Ledgy

Financing rounds

The goal of a company is to grow. The capital needed for growth often comes from equity rounds, if your company is private.

An equity round is for example when an investor - let’s call him Bob - is willing to provide €1 million for 10% of the company. To give the investor 10% of the company, new shares are created. If there were previously 900,000 shares, 100,000 more are created so that the investor now owns 10% of 1,000,000 shares.

The consequences of financing rounds

The new investment not only brings capital into the company but also improves its growth potential and chances of success. All stakeholders benefit from this. It could, for example, be that the company was previously valued at 3M€ and is now valued at 10M€, so the share price has almost tripled.

So what is dilution?

With the next equity round from the above example, the value of the equity will go up, but the percentage of the company you potentially own will go down.

For example, when joining the company you were granted 50,000 shares out of 900,000 total shares of your company. Your ownership stake is 50,000/900,000 = 5.55% of the company.

With the equity round and investor Bob joining, your company issued 100,000 more shares, so your ownership is now 50,000/1,000,000 = 5%.

However, in the most common scenario, the 100,000 shares were issued at a higher price than before, so whilst your percentage ownership is now lower (5.55% → 5%), the value of your stake has increased.

How to calculate what it is now worth? See the next section.

Useful materials to deepen your knowledge:

Anti-Dilution Provision Guide for Startup Founders

Almost all employee participation plans have a vesting schedule. Equity vesting is a crucial mechanism in the world of startups and corporate compensation. It refers to the gradual accrual of ownership rights, typically in the form of company stocks or options, over a predefined period.

A vesting schedule determines how long an employee has to stay employed before being able to exercise the full amount of the grant. Vesting schedules commonly span several years, with a portion of the equity becoming available to the employee at specific milestones or intervals.

The most common vesting schedule is a four-year plan with a one-year cliff, meaning that an employee must stay with the company for at least one year before any equity vests, after which it vests incrementally on a monthly or quarterly basis. For example, a four-year vesting duration would mean that after four years, all of the granted stock options are fully owned by the employee and can be exercised during the exercise windows set up by your company once they are gradually released to the employee. In the graph above you can see how the options were granted on the 10th of January 2022 and they will have finished vesting on the 10th of January 2023.

A cliff is the minimum number of months that an employee has to stay at the company before receiving the first batch of vested options. This term also varies by company and it can range greatly. Cliff only means that the first portion of the vested options is available to you after a fixed period of time. In the graph shown above, the cliff is 12 months. You can see here below how at the end of the cliff a determined amount of options will vest at once. In this case, 25% of a total of 100 options.

Equity vesting is a pivotal element in fostering a sense of ownership and accountability among team members in the dynamic landscape of startups and emerging enterprises.

Here's how vesting of equity stock typically works:

Grant date: The vesting process begins with the grant date, which is when the company awards or grants the equity to the employee or recipient. At this point, the employee receives the promise or grant of shares but does not own them outright. In some cases, the vesting process begins from the vesting start day, not immediately after the grant date.

Vesting schedule: The company establishes a vesting schedule that outlines when you will earn the right to exercise or own the shares. Vesting schedules vary but commonly follow one of these patterns:

Time-based vesting: In time-based vesting, shares vest gradually over a specified period, often in equal installments. For example, a four-year vesting schedule might allow an employee to vest 25% of their shares each year, with the first portion vesting after one year of service. Typically:

• Duration: 48 months
• Cliff: 12 months
• Vesting interval: each month (after the first year)

Custom vesting (for example, time-based)

• 10% in first 12 months, vested every month
• 20% in the second 12 months, vested every month
• 30% in the third 12 months, vested every month
• 40% in the fourth 12 months, vested every month

Milestone or performance-based vesting: Some equity plans tie vesting to specific milestones or performance goals. For example, a company might set vesting based on achieving revenue targets, product development milestones, or other key performance indicators.

Cliff vesting: Cliff vesting involves a waiting period before any shares become vested, followed by full vesting at a specific point in time. For example, a plan might have a one-year cliff, after which all shares vest.

Once shares have vested according to the established schedule or conditions, the recipient gains the right to exercise stock options, i.e purchase shares at the agreed-upon price. Owning the shares lets you potentially benefit from any potential appreciation in the stock's value.

Exercising shares or employee stock options is the process by which an employee or option holder converts their stock options into actual shares of the company’s stock. This process allows them to become a shareholder and potentially benefit from any future appreciation in the stock’s value.

Once your options are vested and the company lets the employee exercise some or all of their vested options during an exercise window, the employee can pay the strike price per share and in return receive common shares. Depending on the agreement with the company, these shares can then be sold at fair market value when certain conditions are met. The conditions are written in the shareholder agreement and may include one or more of: liquidation of the company, change of control on the shareholder level, sale of most of the assets, Initial Public Offering (IPO), etc.

What is the strike price I’ll pay to exercise my options? Is it nominal, or will it increase over time?

The strike price is how much you pay to exercise (buy) your shares. You effectively purchase your shares at a flat rate, making a profit on the difference as the share price increases over time.

How big your discount is can vary. Some employers peg the strike price to the company share price and/or valuation, which means it may change over time for the new grants. Others put the strike price at a static nominal value – often 1p in the UK, and €1 in France or Germany.

Knowing the strike price is important because it tells you how much you’ll need to be able to pay to exercise your shares when they vest. A strike price that looks low on paper can add up when you multiply it by thousands or even hundreds of thousands of shares. If your 10,000 shares have an exercise price of £1, you’ll need to pay £10,000 to buy the rights to your equity when the time comes. Even if your shares are worth more than £10,000, that’s still a significant sum to pay in one go.

Many employers let employees pay for their shares in installments, taken as deductions from their monthly salaries. But most people would still like to know in advance how much they’ll likely have to spend, especially since it could be enough to prevent you from benefiting from the shares you’ve earned.

To exercise your options, you must make a payment either to the company or to a brokerage. The payment is typically the total cost of the shares (number of shares multiplied by the exercise price). This can be done through cash, check, or sometimes by using a “cashless exercise” method where the company withholds some of the shares to cover the cost.

Once the payment is received, the company issues actual shares to the employees, and they become a shareholder with all the associated rights, including voting and potential dividends.

Exercising stock options can be a complex financial decision, and employees should carefully consider the stock’s potential future performance, tax consequences, and their own financial goals before deciding when and how to exercise their options. It’s often advisable to consult with a financial advisor or tax professional for guidance in these matters.

If you understand:

• how much your shares are worth (Equity grants – how, and when, do I get my equity?)

(Number of options/shares in your grants multiplied by the current market price per option/share) - Exercise costs

• when you’ll be able to exercise them (Vesting schedule)
• how much it will cost you to do so (Exercising)
• the effect of dilution on your stake (Dilution)

you can think about what your equity could look like in the longer term, using your current company valuation as a starting point for exploring future scenarios.

With each company event (fundraising, selling shares, acquisition) a company valuation is defined. If you’re unsure about what your company’s latest valuation is, ask internally.

Please note that internal company valuation is different from the tax authority valuation. Many companies also get regular, most commonly annual valuations through the relevant tax authorities. UK companies can agree to a valuation with HMRC with a VAL231 form. The US standard is a 409A valuation; many European companies also choose to undergo 409A valuation processes. (Ledgy partners with Aranca to offer quick and easy 409A, HMRC, and BSPCE valuations for our customers.)

Ledgy tracks the increase in the value of equity over time, and it allows you to see the representation of a new company valuation, which in turn affects the estimated grant value. As an optional feature, you can also use our forecasting tool to set up a future scenario and see how that will change the values (taking into account dilution and additional financing rounds).

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