Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with valued contributions from practitioners across Orrick’s recognised practice areas. Our Band 1-ranked London TCG team successfully completed over 350 financings and tech M&A transactions in 2023 & 2024 totaling $5B+ and has dominated the European venture capital tech market for 37 quarters in a row (Pitchbook, Q1 2025). View previous series instalments here.
Secondary transactions are becoming increasingly common in the UK private company landscape, driven in large part by growing employee demand for liquidity. As companies stay private for longer, employees who have been granted equity often find themselves holding valuable shares on paper – but with no practical way to realise that value. The absence of a clear exit event can be demotivating, particularly for those expecting faster returns through a company sale or IPO.
Against this backdrop, secondary transactions offer a welcome solution: a path to liquidity, without a full-company exit. However, unlocking that liquidity – especially for employees holding tax-advantaged options such as Enterprise Management Incentive (“EMI”) awards – can be raise complex legal, tax and compliance challenges. In the thirty-second instalment of Orrick’s Founder Series, our Incentives team and Technology Companies Group share their key considerations for companies navigating the treatment of employee equity during a secondary transaction.
The Treatment of Employee Equity Varies Depending on the Structure of the Awards
A secondary transaction typically involves the sale of existing shares held by current shareholders to new investors, rather than the issuance of new shares by the company as seen in primary fundraising. The steps required to purchase those shares under employee-held equity awards vary depending on the type of equity award in question:
- Options: Employees must first exercise their options before selling the resulting shares in the secondary transaction. A key question is whether there is an existing right of exercise in connection with the secondary transaction under the option plan documentation.
- Restricted Stock Units (RSUs): RSU terms must provide for vesting on a secondary transaction (or at the board's discretion at any time). The underlying shares are then issued to employees, who are given the opportunity to sell their shares.
- Restricted Stock: If employees already hold shares with restrictions, these restrictions must be released in connection with the secondary transaction to allow for the sale of shares.
Impact on Employee Share Schemes
Several factors must be considered regarding employee share schemes when a secondary transaction takes place:
1. Do the plan rules or equity agreements allow employees to exercise options or vest and settle RSUs as a part of a secondary transaction?
- Because secondary transactions are relatively recent, many share plan rules and option agreements may not include provisions for options to be exercised or RSUs to vest early and be settled during such events.
- Typically, share plan rules only trigger option exercises or RSU vesting and settlement when there’s a significant company event like a sale of the entire business, an IPO, or a change of control. These plans may not automatically allow equity to be released simply because a secondary transaction is happening. It may be necessary to modify share plan terms to remove the change in control contingency, allowing shares to be issued to employees for sale.
- For tax-advantaged options such as EMI and CSOP options in the UK, amending share plan rules to allow employees to exercise options in connection with a secondary transaction, where no such right exists, may inadvertently void the tax benefits. CSOP options are not tax-advantaged if exercised before the third anniversary of their grant. However, non-tax-advantaged option plan rules can be amended without adverse tax implications.
- If an employee’s options have already vested under the plan, they can sometimes be exercised in connection with the secondary transaction without needing changes, but often UK-style “exit-only” plans mean that option holders also need to wait for a change of control to exercise their options. Legal advisors are increasingly drafting new EMI and CSOP option plans to include secondary transactions as a permissible trigger event for the exercise of EMI or CSOP options in connection with a secondary transaction.
2. How should a secondary transaction be communicated, and option exercises facilitated in the UK?
- Effective and timely communication with employees is essential. Typically, it’s best practice to send letters with accompanying documentation well in advance. Employees need to understand how the transaction will affect their share scheme and any changes to their rights or obligations.
- Employees who wish to exercise their options usually need to give formal notice to the company. To streamline the process, the notice can include a power of attorney. This allows the company to handle additional paperwork on the employee’s behalf, so they only need to sign one document. Other documentation may also be required and can then be signed by the attorney, such as stock transfer forms, tax elections, and any share purchase agreement related to the secondary transaction.
- If the UK company has US shareholders and is considering a tender offer or secondary transaction, US securities laws may apply. It is important to assess whether a formal US offer document is required, particularly if employees in the US hold shares. The applicability of US securities laws depends on the number and percentage of US shareholders involved.
3. Do equity awards need to be adjusted during a secondary transaction?
- Before a secondary transaction, companies often restructure their share capital. This could involve consolidating, subdividing, or converting different classes of shares. Such restructurings help align different classes of shareholders, simplify the capital structure, and assist with valuation and pricing.
- In some instances, share capital restructurings impact the value of outstanding equity, requiring adjustments to the number of shares under option/exercise price (or both). This adjustment process may require input from a third-party auditor under share plan rules. Tax-advantaged options like EMI, CSOP options in the UK, and Incentive Stock Options (ISOs) in the US may require adjustments to maintain tax advantages.
4. Are there tax implications when exercising options or RSUs vesting in connection with a secondary transaction?
- In the UK, this depends on whether options/rights have been granted as tax-advantaged EMI or CSOP options. As long as EMI and CSOP options are exercised in accordance with existing plan terms that permit exercise in connection with a secondary transaction, and CSOP options are exercised after the third anniversary of their grant date, the exercise and subsequent sale of shares should result in capital gains tax treatment on any gains made (i.e. the difference between the market value of the shares and the exercise price).
- For non-tax-advantaged options and RSUs, these rights will likely be considered “readily convertible assets” as a result of the secondary transaction, meaning they can be readily converted into cash. Where shares are readily convertible, income tax and national insurance contributions arise on gains made upon exercise of options or vesting of RSUs, payable and reportable via Pay As You Earn (PAYE) payroll.
- In some cases, shares may be acquired in the secondary transaction at a value exceeding their fair market value. In the UK, typically the taxable value should be treated as the amount received in the secondary transaction for those shares which are sold, rather than the actual market value, as UK tax legislation imposes an income tax charge on shares disposed of for more than their fair market value. The tax implications are complicated for employment-related securities, and tax advice should always be sought.
Conclusion
Managing employee share schemes during secondary transactions in UK private companies takes careful planning. To get it right, businesses need to consider several key areas, such as valuation, scheme rules, tax implications, legal requirements, and clear communication with employees.
When these elements are properly addressed, companies can successfully manage the transaction while maintaining the value and purpose of their share schemes. It's a good idea to seek advice from legal and financial experts to help ensure the process runs smoothly and stays compliant.
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