Costs and risks associated with share and option agreements in startups

For startups with limited resources, share and option agreements are important tools for attracting and retaining talent, as well as securing the necessary capital for growth. However, in Norway, as in many other countries, these deals come with both potential benefits and challenges.

In this blog post, we dive into the costs and risks associated with these financial instruments and offer advice on how Norwegian startups can navigate these waters.

Share agreements

Equity deals involve direct ownership in a company. For startups, issuing shares can be a way to raise capital and resources without incurring debt. But it's important to understand both the immediate and long-term costs of issuing shares.

Normally, the shares are purchased at market price and often without any restrictions on ownership and whether or not the shareholder is free to sell shares at will.

In the early phase, when the valuation of the stock (and the company) is still low or difficult to set, shares are often used to trade for expertise, knowledge and other input factors necessary to create value and progress.  

In such cases, we recommend that some restrictions are placed on the share, such as reverse vesting. This will limit the risk for the company selling the share and ensure a fair exchange. You can read more about shares with restrictions here:  

If you are raising capital at an early stage, it may be wise to consider postponing the valuation of the company by using a SLIP agreement. This has several advantages as described here:  

  1. Costs
  • Dilution of ownership: When a startup issues shares, the founder's and existing shareholders' ownership is diluted. This means that their percentage ownership in the company is reduced, which can have a major impact on the control they have over the company's decisions. You should therefore carefully consider who you take on as a shareholder, and have a capital plan that considers the dilution of the founders and key employees over time.
  • Legal and administrative costs: Issuing shares requires legal work to ensure that everything is in line with applicable laws and regulations, which can be costly. Early-stage companies will often manage with a standardized structure, as long as it is coherently designed so that the articles of association, shareholder agreement, share purchase agreements and option agreements are in line with each other.
  1. Risk
  • Market risk: The market's assessment of a startup can fluctuate, which affects the value of the shares, thus posing a risk to the buyer of the shares.
  • Loss of control: By issuing shares to investors or employees, entrepreneurs may risk losing control of the company if they no longer have a majority of the votes. This can pose a risk to the entrepreneurs and, to some extent, to the company.
  • Passive owners: If you issue too many shares and have no restrictions attached to them, you may end up with a large proportion of passive owners. That is, owners who are no longer active and add value to the company. This can have a demotivating effect and make it difficult to secure external investor capital as a result.

Unlisted has developed a standardized legal framework together with lawyers and has helped many early-stage companies set up share incentive programs for the board, employees and freelancers.

Allocate restricted shares to the board, employees and freelancers

Companies that are further along the journey and have a complex ownership structure may need a more customized program developed by a lawyer specifically for them. Such programs are often larger in scope and can be more easily administered using a digital solution that employees can also access.

Digital shareholder book with share incentive program management

Option agreements

Option agreements give the right, but not the obligation, to buy shares in a company at a predetermined price. They are often used to motivate employees and the board, but also come with their own costs and risks.

  1. Costs
  • Administrative burden: Managing option plans requires monitoring and governance, especially when it comes to keeping track of grant dates, exercise windows, price, vesting and tax rules.
  • Tax implications: For both employer and employee, there may be tax implications of option agreements, depending on the exercise price, timing of exercise and sale of shares. It is also important to check if the option scheme for startups can be a good option.
  • Employer's national insurance contributions: It is worth being aware that options can also trigger employer's national insurance contributions.
  1. Risk
  • Change in value: The risk that the options become worthless if the share price falls below the exercise price. This is not a real risk of loss, unless you have paid to access the options (which is unusual).
  • Complications on exit: When selling the company, complications may arise related to the rights of the option holders. If the option program is designed incorrectly, there is a risk that the parties have conflicting interests in this process and that the employees oppose the acquisition.

Unlisted's portal makes it easier to keep track of options, minimizing the administrative burden while maintaining the quality and risk profile of the option program.

We can also advise on how to create an option program that has the right tax and cost profile for the phase the company is in.

Get help with designing an option program

Some concrete tips

To navigate these challenges, it is important for Norwegian startups to:

  1. Have a solid shareholder agreement: This can help clarify the rights and obligations of all shareholders and prevent future conflicts. It is important that this is adapted to the phase the company is in. If there are several entrepreneurs starting up together, it may make sense to regulate what happens if someone is no longer willing or able to contribute.
  1. Have a capital strategy: Carefully consider how much ownership to allocate and to whom, to minimize unnecessary dilution and loss of control, and not least at what stage it is okay to be diluted as an entrepreneur.
  1. Use competent advisors: Engage advisors who specialize in startups to ensure that all aspects of ownership, share and option agreements are correctly handled. It's important to see the big picture; legal, financial and business acumen are essential to success and must work in tandem.
  1. Be transparent and fair: Openness about how and why shares and options are granted builds trust and motivation among employees and investors. Ownership is sensitive and personal for most people and can easily create tension between parties if trust is broken.

Understanding and managing the intricate details of share and option agreements is crucial for any Norwegian startup looking to grow and attract the best talent and investment. Through careful planning, startups can minimize the risks and maximize the benefits these financial instruments offer.

A good idea needs a solid capital strategy and good use of ownership structure to be realized!

Next post
Next post