For startups with limited resources, share and option agreements are important tools for attracting and retaining talent, and for securing the capital needed to grow. In Norway, as in many other countries, these agreements come with both potential benefits and challenges.
In this post, we dig into the costs and risks associated with these financial instruments and give some practical advice on how Norwegian startups can navigate them.
Share agreements
Share agreements involve direct ownership in a company. For startups, issuing shares can be a way to raise capital and bring in resources without taking on debt. But it's important to understand both the immediate and long-term costs of issuing shares.
Normally, shares are bought at market price and often without any restrictions tied to the ownership, meaning the shareholder can sell the shares freely whenever they want.
In the early phase, when the share (and company) valuation is still low or hard to set, shares are often used as a way to exchange for skills, knowledge, and other contributions needed to create value and momentum.
In those situations, we recommend putting some restrictions on the shares, for example, reverse vesting. That limits the risk for the company issuing the shares and makes the exchange a fairer trade. You can read more about restricted shares here: hva-er-restricted-stock-awards-rsa.
If you're raising capital in the early phase, it can be worth considering deferring the company's valuation by using a SLIP agreement. That has several advantages, described here: kapitalinnhenting-ved-bruk-av-slip.
1. Costs
- Dilution of ownership: When a startup issues shares, the founders' and existing shareholders' stakes get diluted. That means their percentage ownership in the company shrinks, which can have a big effect on the control they have over decisions. So think carefully about who you bring in as a shareholder, and have a capital plan that considers founder and key-employee dilution over time.
- Legal and administrative costs: Issuing shares requires legal work to make sure everything aligns with applicable laws, and that can get expensive. Early-stage companies can usually get by with a standardized setup, as long as it's coherent, meaning the articles of association, shareholders' agreement, share purchase agreements, and option agreements all work together.
2. Risks
- Market risk: The market's view of a startup can shift, which affects the value of the shares, and that's a risk for whoever bought them.
- Loss of control: By issuing shares to investors or employees, founders can risk losing control of the company if they no longer hold the majority of votes. That's a risk for the founders and, to some extent, for the company.
- Passive owners: If you issue too many shares without restrictions attached, you can end up with a large share of passive owners, meaning owners who are no longer active and no longer contribute to the business. That can be demotivating and can make it hard to secure outside investor capital later.
Unlisted has developed a standardized legal setup together with lawyers and has helped many early-stage companies put share incentive programs in place for board members, employees, and freelancers.
Companies further along the journey with more complex ownership structures may need a more tailored setup designed by a lawyer specifically for them. These programs are usually larger in scope and easier to administer through a digital solution where employees can also have access.
Option agreements
Option agreements give the right, but not the obligation, to buy shares in a company at a pre-agreed price. They're often used to motivate employees and the board, but they come with their own costs and risks too.
1. Costs
- Administrative burden: Managing option plans requires monitoring and oversight, especially when it comes to tracking grant dates, exercise windows, price, vesting, and tax rules.
- Tax implications: For both employer and employee, option agreements can have tax consequences depending on the exercise price, the timing of exercise, and the sale of shares. It's also worth checking whether the startup option scheme could be a good fit.
- Employer's social security: Worth being aware that options can also trigger the employer's social security contributions (arbeidsgiveravgift).
2. Risks
- Value changes: There's a risk that options become worthless if the share price drops below the exercise price. That isn't a real risk of loss, though, unless you paid for the options upfront (which is unusual).
- Complications at exit: When the company is sold, complications can arise around option holders' rights. If the option program is designed badly, the parties involved can end up with conflicting interests in the process, and employees can work against the acquisition.
Unlisted's portal makes it easier to keep track of options and lowers the admin burden, while keeping the quality and risk profile of the option program in check.
We can also advise on how to design an option program with the right tax and cost profile for the stage your company is in.
Some concrete tips
To navigate these challenges, it's important for Norwegian startups to:
1. Have a solid shareholders' agreement. This helps clarify the rights and obligations of all shareholders and prevents future conflicts. Make sure it fits the stage the company is in. If multiple founders are starting together, it's worth regulating what happens if someone can no longer (or no longer wants to) contribute.
2. Have a capital strategy. Think carefully about how much ownership to allocate and to whom, to minimize unnecessary dilution and loss of control, and especially, at which stage it's acceptable for founders to be diluted.
3. Use competent advisors. Engage advisors who specialize in startups to make sure every aspect of ownership, share, and option agreements is handled properly. It's important to see the whole picture; the legal, financial, and business sides all need to work together for things to succeed.
4. Be transparent and fair. Openness about how and why shares and options are allocated builds trust and motivation among employees and investors. Ownership is sensitive and personal for most people, and tensions can build quickly between parties if that trust is broken.
Understanding and managing the intricate details of share and option agreements is essential for any Norwegian startup that wants 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 a well-built ownership structure to actually come to life.