Giving shares to a staff member: free shares, share options, and what happens the day he leaves

Hook

"Ah Ming has been with me ten years. I want to give him a bit of the company." That is a good thing, and I am all for it. But I usually put three questions to the boss first. In the year he receives those shares, does he pay tax on them? The day he leaves, what happens to them? And at what price do you take them back? Nine bosses out of ten cannot answer the second and the third. And the answers to those two are not settled on the day he leaves. They are settled on the day you give him the shares.

First, be clear: shares, or the right to buy shares

Two ways of doing it, and they are far apart. The first: hand over the shares outright. Sign, transfer, and he is a shareholder straight away. Nothing to pay. The second: give him a share option. What he gets is not shares, it is the right to buy them later at a set price. Usually he has to put in a few years before it vests and he can use it. Where is the difference? | | Outright shares | Share option ||---|---|---|| A shareholder straight away? | Yes | No || Any money to put in? | No | Yes, when he exercises it || Tax straight away? | Possibly | Usually later || Easy to deal with when he leaves? | Hard | Easy |All four differ, but the one that matters most is the last — how easy it is when he leaves. What small companies do most often is hand the shares over outright — and that is precisely the hardest kind to get back. Because once he is a shareholder, he has a shareholder's rights.

Free shares can be taxable (most people never think of it)

Second question: are free shares taxable? They are. Shares an employee receives out of the employment relationship are, in tax law, a benefit forming part of employment income. The idea is simple: the value you received, less the price you paid. Take them for nothing and you paid zero, so the whole value is taxable. (The exact valuation date and the computation are on the episode page, because there are detailed rules there.) But then the question comes — what is the market price of shares in a private limited company? There is none. No exchange, no quotation, nobody trading your company's shares day to day. So this is what happens. Ah Ming gets his shares and he is delighted. Come filing time he finds he owes tax on them, and he has no way of turning the shares into cash to pay it. He will not feel you have given him something. He will feel you have handed him a problem. So: before you give, make it plain — when the tax arrives, and who carries it. That one sentence saves you a very ugly conversation.

He leaves — the company buys them back? (the answer is the opposite of what you think)

Third question, and the one bosses ask most: "He has left, the company just buys the shares back, doesn't it?" No. Here is a hard fact a lot of people do not know: your private limited company cannot buy back its own shares. So the route of "the company buys them back" — generally speaking, it does not exist. What do you do in practice? Three routes. One, another shareholder buys them — usually you, the boss. The most common and the cleanest. ⚠️ But note this: the money comes out of your personal pocket, not the company's. Two, the new employee taking over that post buys them. The shares circulate with the post, and many companies design it that way. Three, a statutory procedure such as a capital reduction. ⚠️ That carries a whole separate set of conditions and formalities — take professional advice, do not do it yourself.

At what price? There is no default answer

So how is the price set? The law does not give you a default price. There is only the price you wrote down at the start. Four bases are common. First, net asset value — the company's assets less its liabilities, taken at his shareholding percentage. Simple, but unfair to an asset-light business (a point we made in the episode on valuation). Second, a multiple of earnings — profit times an agreed multiple. Third, return of the original price — he goes out the way he came in. Best for the company, and hardest on an employee who has put in many years. Fourth, bring in an independent valuer. The fairest, and also the most expensive and the slowest. And there is one more idea that almost every decent shareholders' agreement carries — the good leaver and the bad leaver. A normal resignation, retirement, illness — that is a good leaver, at one price. Breach of contract, walking off with the customers, dismissal — that is a bad leaver, at another price.

So write three things down before you give

An employee share arrangement that actually works sets down three things before anything is handed over. First, how they come in. How much, on what conditions, and whether they vest over time — so much after a year, so much after three. Second, how they go out. Are they handed back on leaving? Who buys them? At what price? How do you separate a good leaver from a bad one? Third, what rights he has while he is there. Does he vote? Can he see the accounts? Does he get a share of the profit? ⚠️ And one more thing worth doing while you are at it: read the constitution. See whether the pre-emption right is still in there — because when the company issues new shares later, his percentage is affected. Where do you write all this? The constitution, a shareholders' agreement, or a formal scheme document. The form is negotiable; being in writing is not.

"The boss promised me, and it never came"

This last part is for employees as much as for bosses. "He said before that if I did well he would cut me in." The reality first: without something in writing it is very hard to argue. Because "I will give you a share later" answers none of four questions — how much? when? shares or a share of the profit? on what conditions? A promise that answers none of the four is very hard to turn into something a court can enforce. So what does help? Beyond black and white: WhatsApp, email, minutes of meetings, and whether anything was actually shared out in the past. If it has happened once, there is a course of dealing to point to. In an accounting firm or a law firm, partnership adds another gate. "Make manager and we will make you a partner" — even if that boss genuinely means it, the partnership legislation says no new partner may be introduced without the consent of all the existing partners. One person's promise does not settle it. So if you are the one who was promised, the question to ask is not "when are you giving it to me", it is "who has to agree to this, and do they know".

Before a listing, and to close

Some bosses ask: "What if I want to list one day?" Two things. First, if the shareholding needs tidying up, do it early. After a listing there is a moratorium, and the controlling group cannot sell for a period. Second, handing shares to staff in a rush just before a listing can run into the rule that shares acquired cheaply before a listing get locked up. In a sentence: if you want to give employees shares, give them while you are still small — it is simplest then. The closer you get to a listing, the more rules there are. Finally, one thing I want to say to bosses. If you genuinely mean to give, write it down. "I will see you right one day" is a promise in your head, an expectation in his, and in law — nothing at all. Three years later it only turns into a conversation nobody enjoys. Want to turn employee shares from a sentence into a document? Grab a coffee first and talk about your business. For the accounting, come to LTT. I am LTT, helping SME bosses get their accounts straight. Follow us, and see you next time.