Share options and start-ups

Todays Financial Review carries an article whining about the new tax rules on shares options.

A quick summary: The government have changed the tax rules so that shares granted are taxed on receipt, instead of when the shares are eventually sold.

Example (taken directly from the newspaper in another article):¬†Suppose company X has little money and does not want to pay big salaries. So it gives it’s employees share options in the company. The option entitles the person to receive shares at a fixed price at some later date – usually provided certain performance targets are met. The assumption is that the shares will be worth more than is paid for them, and when sold the government gets its slice via capital gains tax and the employee cleans up. This compensates for a lousy salary.

[Just to muddy the waters, examples are being thrown around citing cases where employees receive shares, rather than options, to prove that there will in the long term be less tax paid. Gah. Keep the story consistent, please.]

The particular whinge is for start-ups who want to issue options rather than shares, and do this instead of salary – or in leiu of a larger salary.

The reason the government have changed the rules is simple – it’s a loophole. If an employee is paid in cash, then income tax is paid. If an empl0yee is paid in kind (school fees, house mortgage, etc) then Fringe Benefits tax is paid. So why should the issue of shares or options be any different?

Next… bear with me… Options.

The trouble with options is folk (and especially company directors) think they are somehow magical: they cost the company nothing but give great value to the employee. The ultimate Magic Pudding. The trouble with options is they are a RIGHT to do something at a later time. There is no obligation to exercise the right. (Suppose the share price tanks and is below the price at which the options can be used to buy shares… you’d hardly exercise the options if you could buy cheaper on the open market.) So placing a value on the options is difficult. If the market value rises, the options are worth something. If the market value falls, the options are just a bunch of junk.

So the effect of the changes to the tax law is to make it difficult or expensive to issue options, and doubly so because tax has to be paid up front for something of unknown future value.

Perhaps it’s a good time to get rid of the unscrupulous and immoral practice of issuing options!

If start-up companies REALLY want to give their employees some stake in the company with a future benefit through share sales, they can just fall back on the good old fashioned way. SELL THE EMPLOYEES THE SHARES! This is done all the time. It’s called a Capital Raising.

Furthermore, in a private company, or an unlisted public company Рthere is no open market, so the share price is whatever the parties agree it should be. There is plenty of scope for selling employees shares at an (agreed) low price. No options. No grant of free shares. No problem. Stop bloody whining.

One Comment

Shares confuse me. I’ll stick with cash.

Comment by river | May 25th, 2009 6:20 pm | Permalink

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