Italy Founder Series: Stock Option Plans

Italiano: Italy Founder Series - Piani di Stock Option

Startups often cannot pay the high salaries of larger companies. By offering stock options, however, they can build competitive compensation packages that align employee and shareholder interests. To help startups and small and medium-sized enterprises, the Italian government has introduced a favorable tax scheme for stock option plans.

This article provides an overview of stock options for Italian startups. It covers how to use them to attract, retain and incentivize the team.

Stock Options: An Opportunity for Employee Growth

A stock option plan allows employees to acquire company shares at a predetermined "exercise price" or "strike price." The price usually is lower than market value. Employees typically are eligible after a vesting period and after meeting certain conditions.

An option is a right (not an obligation) to purchase shares in a company. Unlike the issuance and allocation of shares, it does not make the beneficiary a shareholder until that person exercises options.

Stock options can motivate employees to contribute to the company's success: the value of their potential shares grows with the company's value.

Key Elements of a Stock Option Plan

1. Capital Allocated to Employees

The company will determine how much capital to allocate to its stock option plan. It must strike a balance between motivating beneficiaries and limiting the dilutive effect for other shareholders.

2. Identifying Beneficiaries

The company chooses who can receive stock options. The plan can be reserved for top management and key team members or distributed to a broader group, depending on corporate targets (retention or talent attraction).

Options are generally granted to employees and directors, but a company can also grant them to consultants, advisors and other third parties. The favorable tax treatment for stock option plans (described below), however, applies only to beneficiaries who are employees.

3. Exercise Price of Options

The exercise price is the price at which beneficiaries can purchase shares. Companies should set the price to make stock options attractive without excessively diluting the company's asset value and, indirectly, the value of other shareholders' shares.

The exercise price can be set at the nominal value of the shares (i.e. a symbolic price). That happens often in early-stage companies. Later, the price more often aligns with the value attributed to the company in the investment round in which the plan is established, possibly with a discount factor.

4. Vesting

Vesting establishes if and how employees acquire the right to exercise options.

• Typically, a vesting schedule provides that the number of exercisable options increases (and therefore options "vest") based on time elapsed or the achievement of corporate or individual performance targets.
• The greater the number of vested options, the greater the participation the employee would be entitled to by exercising the options.

The vesting schedule helps retain employees by rewarding beneficiaries for staying with the company or contributing to corporate results. Normally, the vesting period is structured over four or five years. In some plans, options do not vest during an initial “cliff” period.

5. Exercise Period

Sometimes employees can exercise options as they vest in predetermined time windows. In other cases, option-holders can exercise options only after a "liquidity event," such as a company sale or listing.

A liquidity event limits the number of individuals who become shareholders. That effectively allows beneficiaries to exercise options at the same time they liquidate shares in an exit.

6. Lock-up Period

In some cases, beneficiaries cannot immediately sell acquired shares. That encourages them to stay with the company and align exit times with those of other shareholders.

7. Termination of the Employment Relationship with Beneficiaries

Most plans address what happens to options when a beneficiary leaves the company. These provisions typically define cases of "good leavers" and "bad leavers."

• Good leavers generally leave for just cause or are dismissed without just cause. Good leavers typically can exercise vested options in a certain period. Unvested options lapse.
• Bad leavers depart without just cause or are dismissed for just cause. Unvested and vested options generally lapse.

8. Exit Events

Generally, in an exit, such as a company sale, option holders can exercise vested options immediately. Sometimes, vesting "accelerates" so a beneficiary’s unvested options vest and become exercisable.

Implementing a Stock Option Plan

Companies usually implement stock option plans through dedicated capital increases or treasury shares. Some group companies can allocate shares of other group companies.

The board of directors usually prepares and approves plan rules.

Tax Benefits

To encourage adoption of stock option plans, Italian law provides tax exemptions for beneficiaries at startups and small and medium-sized enterprises. These exemptions allow startups to pay employees through the allocation of capital instruments (such as stock options) instead of monetary compensation.

For startups and small and medium-sized companies that qualify as "innovative," income from stock option allocation to directors, employees and collaborators is not subject to taxation until the shares are sold, except for some anti-avoidance limitations.

• When shares are sold, only capital gains are taxed, at 26% instead of the marginal IRPEF rate.
• The taxable base is calculated on the difference between the sale and exercise prices.
• This is an exception to standard rules for companies that do not qualify as innovative; those rules provide for taxation on all compensation derived from employment.

However, an anti-avoidance clause prevents repurchasing shares resulting from option exercise by entities such as the company itself, its shareholders or controlled companies. If this occurs, the beneficiary is to declare the value of the shares at the time of allocation as employment income and pay taxes on any value obtained. Therefore, beneficiary liquidation ideally should occur in an exit, as different plan monetization would result in the loss of tax benefits.

Our Tech Team is at your disposal to provide advice on structuring your company's incentive plan and support you with administrative requirements so that you can focus on your startup's growth. If you want more details on one of the topics mentioned above, or to discuss how to establish your startup or how our team can help you, please contact the authors of this article.