Ordinary Shares themselves can be issued in different classes, carrying different rights. A notable example of this is in Facebook where the class-B “common stock” (US-speak for Ordinary Shares) carry 10 votes per share, as opposed to the class-A common stock, which carry 1 vote per share.

While this does not increase the economic returns of the class-B common stock, it gives those shareholders a significantly increased say in certain corporate actions, like selling the company. Mark Zuckerberg is a significant holder of class-B common stock in Facebook. That’s awesome for Mark Zuckerberg, but is not likely to be something any investor will agree to for the rest of us.

When you first incorporate, shares are allocated a “par” or “nominal” value. This is a somewhat archaic term that, in theory, represents the initial price for which shares are subscribed (bought). However, the par value of a share bears no real relation to the market value of that share and thus is a notional value only.

It becomes important when you account for shares, with any amount paid above the par value being allocated to your “share premium account.” Par value is usually a very small amount, e.g. €1 or even €0.00001 each.

Many people talk in percentage terms when talking about share options. While percentages are fine to use as a general description, make sure to put a fixed number of shares against this percentage when discussing in writing.

• for example, you could initially promise 0.5% of the company to a new adviser — let’s say that equates to 5 shares at the time. If time passes before you formalise the arrangement, you could have done another funding round in the meantime, and another 1000 shares could have been issued. After that funding round, 0.5% could equate to 10 shares. But you meant to grant the adviser 0.5% of the company at the time of the initial conversation, 5 shares. If you haven’t clarified it, you could easily end up in a disagreement with your adviser. 
• the best way to talk about options therefore is to also mention a fixed number; e.g. “We’re delighted that you are coming on board as an adviser. As part of your package, we will grant you options to purchase 5 shares in our company, which, as of today, equates to 0.5% of our issued share capital. We don’t have a formal option scheme just yet but, when we do, the terms of the scheme will cover all share options, including yours.”

Avoid talking about share options in terms of value, e.g. “we’ll grant you €30,000-worth of share options.” People generally talk in these terms when they allocate a “value” to the shares the same as the price per share at which an investor last bought shares. There are two problems with this approach:

• if you don’t formalize the absolute number of options and have another funding round (likely at a different per-share price), your initial assessment of “value” becomes a moving target, which can lead to misunderstandings
• it’s likely that investors will purchase preference shares of a different class to those ordinary shares that would be granted to option holders. The intrinsic value of option shares is likely to be lower than the price paid by investors for a higher-class share. In addition, it is of benefit to an employee to have as low an exercise price (the price they pay for the share) as possible, so you can end up in a conflicting situation, wanting the exercise price to be low but still trying to say to someone that the shares are “worth” much more. The advantage of share options lies in the upside — the hope that the shares will someday be worth more than the price the employee has to pay for them. Talking in terms of present-day value can be misleading and is not useful to communicate the actual potential value of the option.

A share option is an option to purchase a share in the company at a price agreed at the time of grant of the option. While a number of share options may be granted on a certain date, it is usual to permit option-holders to only exercise those options (i.e. convert them into shares) based on the passage of time or some other condition, such as the option holder/company hitting certain targets. 

The rate at which options become capable of being exercised is known as the “vesting schedule.” You will commonly see employee share options vest over a 4-year schedule with a “cliff,” which means that no options vest for the first period of time (e.g. a year) but then a full year’s-worth of options vest on the first anniversary of the date of grant. There are numerous vesting schedules that are common, such as:

• 1-year cliff and monthly vesting over the following 3 years (total 4 years)
• monthly vesting throughout a 4-year period
• 1-year cliff and annual vesting thereafter
• 1-year cliff and quarterly vesting thereafter

The arguments for different vesting schedules are:

• because share options are used to retain employees, there should be a minimum period during which they stay with the company before they should be allowed to exercise options
• having an annual vesting schedule encourages employees to stay until their next vesting period, but possibly increases the risk of them leaving directly after a batch of options have vested

It is not unusual for advisers and board members to have slightly different vesting schedules, e.g. over 2 or 3 years.

The exercise price of a share option is the price per share that an option holder pays if and when they exercise the right to convert the option into a share. Usually the exercise price is set at “fair market value” of the underlying share at the time the share option was granted. 

For private companies, it can be hard to assess what a fair market price is for a share. At the very beginning, the market value may be close to zero. If a company has received funding, it can use that share price as a reference point to assess fair market value. However, the value of a share subject to an option will likely be less than the price paid by an investor for a preference share or a share carrying more rights than an ordinary share. In practice, the “fair market” value of an ordinary share may be expressed as a discount off the price paid by an investor for a preference share. The discount will depend on the difference between the rights carried by the preference shares and ordinary shares and can be anything up to an 80% discount.

A really important concept for you and your option holders to understand is that, if you grant share options with an exercise price of fair market value, you are not immediately providing value to the option holder — the whole point of share options is that the option holder hopes to make money if the value of the shares increases. 

Taking vesting out of the equation, when you grant e.g. 1000 share options at an exercise price of €1.00 each (let’s say that’s fair market value), at the date of grant all you are offering the option holder is the right to buy €1000-worth of shares for €1000. The advantage to the option holder is that they do not have to hand over the €1000 immediately on the date of grant, but they lock in that price for the future and so, if and when the shares are worth €100 each, they can still buy those shares for €1.00 each and sell them for €100 each if there is an exit/sale of the company. The value is all in the potential.

The main intention behind share options and vesting arrangements is to motivate employees and others to both stay with the company and increase overall shareholder value. Where share options vest and have been exercised, the option-holder becomes a shareholder of the company and can share in the profits/value, e.g. if the company is sold.

Once someone becomes a shareholder, they will generally have the right to vote on or approve certain corporate actions. While the intention behind share options is that the subsequent shareholder will benefit from the economic rights of the share (i.e. to receive money on an exit), it is preferable that such shareholders are not permitted to “hold the company to ransom” via their voting rights. While many corporate actions require a 50% or 75% majority vote in favour, in certain circumstances, such as an acquisition, the acquirer may require that 100% of shareholders sign the acquisition documents. While there is a statutory (legislative) procedure whereby 80% of the existing shareholders can force the remaining 20% of shareholders to sell their shares, that process takes time and, as the saying goes “time kills deals.” Uncertainty is to be avoided at all costs when you are in the full throes of an acquisition.

It is recommended that all small individual shareholders (and option shareholders in particular) either (i) hold their shares via a “nominee scheme” whereby the shares are issued to a separate company which holds the shares for the benefit of the individual, or (ii) as a condition of exercising a share option, grant another person connected with the company (usually a founder-director) a power of attorney over those shares, such that the founder-director is authorised to sign any documents approved by other shareholders on behalf of the option-shareholder.

This is for two reasons: (i) so that corporate actions can be taken quickly without having to track down each and every shareholder, and (ii) so that small individual shareholders cannot take disproportionate advantage of something like an exit scenario by refusing to sign documents unless they receive something over and above their normal entitlements.

A warrant is essentially a share option; it allows the warrant-holder to subscribe for shares in the future for a price agreed today. The price can be fixed or can be expressed as a discount off a future funding round price. The difference between a warrant and convertible loan is that, with a warrant, the company is unlikely to get money upfront for granting the warrant; the money only comes in if the warrant is exercised and shares are granted. Warrants are often issued alongside a separate investment to institutional/professional investors or alongside a service or banking agreement to third-party service providers or banks.

A convertible loan is a cash loan that can be converted, usually at the option of the “loan note” holder, when a future equity (share) investment is completed. A convertible loan usually consists of (i) a Note Purchase Agreement, executed by the company and each of the people providing the loan, and (ii) a Loan Note, which is the certificate representing the actual loan.

The advantage of a convertible loan is that it is not necessary to immediately ascribe a value to the company, which can be difficult to assess in the very early stages of development. Convertible loan documentation is also usually less complex than the shareholders’ agreement required by an equity investment.

Expect to see the following in a convertible loan:

• a conversion event: usually a future equity investment raising a minimum amount of money. This is the trigger for the loan to be converted into shares. The choice to convert can be either (i) company-friendly whereby the investor must convert unless the company decides otherwise, or (ii) investor-friendly, whereby the investor has the option whether to convert the loan or have the loan paid back.
• a conversion price: the price at which the loan will convert to shares on a conversion event. The price can be set at a discount off the price-per-share of a future investment round.
• an interest rate: interest would normally be either paid out at conversion or applied to subscribe for more shares at conversion.
• a term: this is the time period by which the loan will have to be either paid back or converted. If a conversion event doesn’t happen within the term, either the loan will have to be repaid or converted to shares at a pre-determined price or for a pre-determined percentage ownership, outlined in the loan document at the outset.
• various vetoes/permissions whereby the investor’s consent must be obtained to take certain actions. These will be similar to vetoes in shareholder agreements but are usually less detailed and more high-level.

Sometimes there will be a “cap” on a convertible loan, or a minimum percentage of share capital that the loan amount will convert into when it is converted.