Common Mistakes in Setting Up Share Schemes

Employee share schemes can be one of the most effective ways to attract, motivate and retain talented people, particularly in growth businesses where cash needs to be preserved and a long-term “owner mindset” matters.

However, share schemes are also an area that often causes issues during due diligence exercises. Problems often stay hidden for years, then surface during a fundraising round, sale, restructuring or when a senior employee leaves. The result can be unexpected tax bills, disgruntled option-holders, delays to a transaction or the loss of valuable tax advantages (especially under EMI).

This article sets out the most common mistakes we see when companies set up share schemes, and what you can do to avoid them, across EMI, CSOPs, growth shares, unapproved options, phantom plans and direct share issues.

1. Starting with the scheme type before deciding the commercial goal
2. Underestimating HMRC reporting and compliance
3. Getting valuations wrong (or not documenting them properly)
4. Treating scheme documents as “templates” rather than tailored legal instruments
5. Weak leaver provisions (or none at all)
6. Designing vesting and performance conditions that don’t work in real life
7. Forgetting about dilution and option pool strategy
8. Poor employee communication (creating unrealistic expectations)
9. Misunderstanding phantom share schemes
10. Not aligning growth shares with the company’s actual growth stor

For more information about the different types of share schemes and which may be the best fit for your company, please click here to read: What is the Best Share Scheme for My Company? 

1. Starting with the scheme type before deciding the commercial goal

A surprisingly common error is choosing a structure (e.g. “we want EMI”) without first answering:

• What behaviour are we trying to drive – retention, performance, exit alignment, recruitment, or all of the above?
• Who do we want to include – only employees, or also consultants, advisors, non-execs?
• What’s the time horizon – 12 months, 3–5 years or “until exit”?
• Do we want employees to become shareholders now, later or never?
• Do we want to manage dilution through an option pool?

Why it matters: 

Choosing a share scheme before clearly defining what you want it to achieve is one of the most common (and costly) mistakes we see. Equity incentives are long-term arrangements, often running for several years and intended to operate through fundraising rounds, management changes and, ultimately, a sale or other exit. If the underlying design does not reflect the company’s real objectives, problems tend to emerge at the worst possible time.

In practice, a poorly thought-through scheme often leads to friction later on, such as:

• Mid-life restructuring: companies realise the scheme no longer works (for example, it rewards the wrong people, or doesn’t align with how value is actually created), requiring a restructure that can be legally complex, tax-inefficient and unsettling for participants.
• Re-pricing or re-granting awards: where growth has not materialised as expected, or where options were granted at an unrealistic exercise price, businesses may feel pressured to “fix” awards that no longer provide meaningful value. This can raise fairness issues, tax risks and governance concerns, particularly if investors are involved.
• Exit-driven amendments: problems often surface during a sale or investment round, when buyers or investors scrutinise share schemes closely. At that stage, there is little appetite for ambiguity, yet companies may find themselves rushing to amend documents, clarify leaver outcomes or correct historic errors under intense time pressure.
• Employee dissatisfaction or disputes: if participants feel the scheme doesn’t deliver what they believed it would, or if outcomes on departure or exit feel inconsistent or unfair, this can damage morale and, in some cases, lead to disputes.

All of this can distract management, increase legal costs and, in a worst-case scenario, delay or even jeopardise a transaction.

How to avoid these problems: 

Before drafting any legal documents or choosing a particular scheme type (such as EMI, growth shares or phantom shares), it is usually worth stepping back and preparing a short, high-level scheme brief. This does not need to be complex. In many cases, a single page is enough.

That brief should address the following points:

• Purpose: What is the scheme designed to achieve? For example, is the priority retention, incentivising growth, rewarding past contribution or aligning the team with an eventual exit?
• Eligibility: Who should participate? Employees only, or also consultants, advisors or non-executives? Should everyone be eligible, or only key individuals?
• Award size and structure: How generous should awards be, and how will value be measured or communicated? Is there an overall pool and how will future hires be accommodated?
• Vesting and triggers: When do participants actually earn their equity? Is vesting time-based, performance-based, exit-based or a combination?
• Leaver intent: In broad terms, what should happen if someone leaves? Should “good leavers” keep some value? Should “bad leavers” lose everything? Clarity here avoids difficult conversations later.
• Exit mechanics: How should the scheme operate on a sale or IPO? Should awards accelerate? Should participants be forced to sell alongside other shareholders? Should there be any caps or thresholds?

By answering these questions up front, the company can then choose the most appropriate scheme structure and draft documents that genuinely reflect its commercial intentions. This approach significantly reduces the risk of needing to revisit or amend the scheme later, particularly at critical moments such as a fundraising round or an exit.

In short, a modest amount of planning at the outset can save considerable time, cost and disruption further down the line.

2. Underestimating HMRC reporting and compliance

Missing annual ERS filings

HMRC expects a return by 6 July following the end of the tax year, if you operate an employment-related share plan or after a reportable event occurs. This includes share option grants and one-off share awards. Late filing can trigger penalties. 

Assuming “nothing happened” means nothing needs to be filed

One of the most frequent compliance errors we see is the assumption that no activity means no obligation. In reality, once a company has registered a share scheme or has made any employment-related securities arrangements, HMRC expects an annual return to be filed, even if no new awards were granted during that tax year.

This misunderstanding often arises because share schemes operate infrequently. A company might grant EMI options one year, then do nothing for several years while the business grows. During that quiet period, filing obligations can easily fall off the radar.

Failing to submit a return (even a nil return) can trigger automatic penalties, create unnecessary correspondence with HMRC and, more importantly, raise red flags during due diligence in a sale of the company.

Losing access to the Government Gateway / ERS account

Share scheme compliance often sits in a grey area between legal, finance and payroll. A practical problem we regularly see is that ERS accounts are set up using:

• a personal Government Gateway ID, or
• an email address belonging to a finance employee who later leaves the business.

When that person moves on, access to the ERS portal can be lost entirely. Recovering access can be time-consuming and frustrating, particularly if HMRC needs to be contacted to reset credentials or verify authority.

This becomes especially problematic when a transaction is underway and filings or confirmations are needed quickly.

How to avoid these problems

The solution is largely administrative, but extremely effective:

• Put the 6 July deadline firmly into your annual compliance calendar.
• Assign responsibility to a named individual or role (e.g. Finance Director or Company Secretary), rather than a shared inbox or “someone in finance”.
• Ensure ERS login details are centrally recorded and not tied to a single departing employee.
• Treat nil returns as just as important as returns reporting actual activity.

A simple, repeatable annual process significantly reduces the risk of penalties, delays and awkward questions later.

Missing EMI grant notifications (and misunderstanding the deadline change)

For EMI grants, the notification rules changed:

• For options granted on or after 6 April 2024, the grant must be notified by 6 July following the end of the tax year.
• For options granted before 6 April 2024, the grant had to be notified within 92 days of grant.

Why this matters

For EMI schemes in particular, notification and reporting failures are one of the most common issues flagged during exit due diligence. 

From a buyer’s perspective, EMI options represent a potential tax risk. If an option has not been properly notified to HMRC, there is a concern that the favourable EMI tax treatment could be invalidated. This can affect:

• • the net proceeds received by option holders, and
  • whether the company could face claims or indemnities if employees suffer unexpected tax charges.

As a result, buyers and investors will often scrutinise EMI compliance carefully and may require warranties, indemnities or remedial action if any uncertainty exists.

Common pitfalls with EMI notifications

Historically, many problems arose because companies were required to notify EMI grants within 92 days of grant, and this deadline was frequently missed. Although the rules have since changed (with grants from April 2024 moving to an annual notification deadline), legacy grants are still often reviewed during due diligence.

Common issues include:

• • options granted but never notified at all;
  • notifications made late or with incorrect details;
  • reliance on informal emails or internal records instead of formal HMRC confirmation.

How to avoid these problems

Even though the formal deadlines have become more flexible, best practice remains the same:

• • Do not wait until the end of the tax year to deal with EMI notifications.
  • Build a process where grants are reported shortly after completion, while documents, valuations and approvals are still readily available.
  • Keep a complete EMI “audit trail”, including board approvals, option agreements, valuations and evidence of HMRC submissions.

This approach reduces the risk of errors and makes future due diligence far smoother.

Important change: no EMI notifications from April 2027

It is also worth noting that from April 2027, EMI options will no longer need to be notified to HMRC at all. This change is intended to simplify the regime and reduce administrative burden for companies.

However, this does not remove the need for:

• • accurate documentation,
  • correct valuations, or
  • annual ERS filings where applicable.

In addition, historic grants made before April 2027 will still be reviewed in any exit or investment due diligence process. Companies should therefore continue to treat EMI compliance seriously and avoid assuming that future simplifications remove the need for robust processes today.

3) Getting valuations wrong (or not documenting them properly)

Share schemes rely on a clear understanding of what a company is worth at the points shares are issued or options are granted. Valuation errors are one of the quickest ways to cause tax pain and undermine trust.

Using outdated valuations or “rule of thumb” figures

A very common mistake is relying on an old valuation (for example, one prepared for a fundraising round many months earlier) or using an informal “rule of thumb” number, such as applying a multiple to turnover or profit without proper analysis.

This approach often stems from a desire to keep things simple or move quickly, but it creates risk. Company value can change significantly over relatively short periods, particularly in fast-growing businesses. Granting options based on an outdated valuation can mean:

• the exercise price is set too low, increasing the risk of unexpected Income Tax or NIC charges; or
• the exercise price is set too high, leaving employees demotivated and reducing the incentive value of the options.

In either case, the lack of evidence to support the figure makes it harder to defend if challenged by HMRC or scrutinised during due diligence.

Ignoring the impact of share restrictions on value

Another frequent oversight is failing to consider that shares subject to restrictions are not worth the same as unrestricted shares. Many employee shares are subject to restrictions such as:

• forfeiture on leaving;
• compulsory transfer provisions;
• restrictions on dividends or voting rights; or
• limitations on transferability.

These restrictions can significantly reduce the market value of the shares for tax purposes. If they are ignored, the valuation may overstate the true value of the shares being awarded, increasing the risk of adverse tax treatment for employees.

Conversely, assuming a discount without properly analysing or documenting it can also be problematic. HMRC expects any discount for restrictions to be justifiable and supported by reasoning, not applied arbitrarily.

Setting exercise prices without recording the rationale

We often see option exercise prices that appear to have been “picked” without a clear paper trail explaining how the figure was arrived at. This is particularly risky for EMI and CSOP options, where tax treatment depends heavily on whether the exercise price reflects market value at the date of grant.

Without contemporaneous records, it can be very difficult (sometimes years later) to demonstrate that the exercise price was appropriate. This can cause issues when:

• HMRC raises queries;
• employees exercise options and unexpected tax liabilities arise; or
• buyers’ advisors ask for confirmation that EMI or CSOP requirements were met.

Growth shares: misaligned or accidental value at grant

Growth shares bring additional valuation challenges. The purpose of growth shares is that they should only participate in future value, not existing value. However, common mistakes include:

• setting the hurdle too low, so that the shares have immediate economic value on issue;
• using a hurdle that does not align with how exit proceeds will actually be distributed; or
• failing to test the economics under different exit scenarios.

If growth shares have more than a negligible value at grant, the recipient may face an unexpected Income Tax charge upfront, often before any real value has been realised. This can undermine the incentive entirely and create employee dissatisfaction.

How to avoid these problems

Use a valuation approach appropriate to your company and scheme

There is no single “right” valuation method. The appropriate approach depends on factors such as:

• • your company’s size, stage and funding history;
  • whether the scheme involves options or actual shares;
  • the class of shares being awarded; and
  • the presence of restrictions or performance conditions.

Early-stage companies may use different methodologies from more established businesses, but in all cases the valuation approach should be reasonable, defensible and proportionate to the scheme.

Keep clear, contemporaneous records

Good valuation practice is as much about record-keeping as it is about the numbers themselves. You should retain written records of:

• • the valuation methodology used;
  • key assumptions and inputs;
  • any discounts applied and the reasons for them; and
  • board approvals or decisions relating to the valuation.

These records are invaluable if questions arise years later, particularly during an exit, when memories have faded and key individuals may no longer be involved.

Align valuation timing with grant timing (especially for EMI and CSOP)

For tax-advantaged schemes such as EMI and CSOP, timing matters. Delays between valuation, board approval and grant can create uncertainty about whether the exercise price still reflects market value at the relevant date.

Common issues include:

• • valuations becoming stale before options are formally granted;
  • grants being backdated informally; or
  • changes in the business occurring between valuation and grant.

To avoid this, valuation, approvals and grant documentation should be closely coordinated. Where there are delays, it may be necessary to revisit or refresh the valuation rather than relying on outdated figures.

Getting a valuation right at the outset requires some upfront effort, but it is far less costly than trying to correct mistakes later. Proper valuation protects both the company and the individuals receiving equity and helps ensure the scheme delivers the incentives it was designed to create.

4) Treating scheme documents as “templates” rather than tailored legal instruments

Share scheme paperwork tends to include plan rules, individual grant documents, board and shareholder approvals, and sometimes amendments to the company’s articles of association and/or shareholders’ agreement.

Using generic documents that do not reflect your company’s structure

A common mistake is relying on generic or lightly adapted precedent documents that are not properly tailored to the company’s actual share structure or ownership dynamics.

For example:

• the option plan assumes a single class of ordinary shares, but the company has multiple classes with different rights;
• the plan assumes a simple cap table, but the company already has preference shares, growth shares or convertible instruments in issue.

These inconsistencies often go unnoticed at the time of grant, but they can create confusion or disputes later, particularly when options are exercised or when proceeds are allocated on an exit.

Failing to align scheme mechanics with the company’s articles of association and shareholders’ agreement

Another frequent issue is that the share scheme documents say one thing, while the company’s articles of association or shareholders’ agreement say another.

Common areas of misalignment include:

• Leaver provisions: the scheme may say that options lapse on departure, but the articles or shareholders’ agreement do not support compulsory transfer or forfeiture of shares once issued.
• Transfer restrictions: option-holders or employee shareholders may technically be able to transfer shares, even though the scheme assumes they cannot.
• Drag-along and tag-along rights: the scheme may assume that option-holders or employee shareholders will be forced to sell on an exit, but the constitutional documents may not actually permit this.
• Consent and approval mechanics: the scheme may allow the board to grant or vary awards, while the shareholders’ agreement requires investor consent for those actions.

If these documents are not properly aligned, the company may find that it cannot enforce the outcomes it assumed were available, particularly in contentious situations or during a sale.

Not updating scheme documents after fundraising rounds or restructurings

Share schemes are often implemented early in a company’s life and then left untouched while the business evolves. Problems commonly arise after:

• a venture capital or private equity investment;
• the introduction of new share classes or preference shares;
• changes to veto rights, consent matters or investor protections; or
• a group reorganisation or restructuring.

In these scenarios, the original scheme documents may no longer reflect the commercial or legal reality of the business. For example, an option plan may allow the board to amend vesting terms, but post-investment documentation may require investor consent for any variation to employee equity arrangements.

If scheme documents are not reviewed and updated at these points, companies can inadvertently breach investor agreements or create uncertainty around the enforceability of awards.

How to avoid these problems

Treat the share scheme as part of your corporate architecture

A share scheme should not be viewed as a standalone HR or reward tool. It is a core part of your company’s corporate and ownership structure and should be treated with the same level of care as your articles, shareholders’ agreement and investment documents.

In practice, this means:

• • designing the scheme with full visibility of your cap table and existing share rights;
  • ensuring the scheme documents are expressly supported by the articles and shareholders’ agreement; and
  • checking that consent and approval mechanics align across all documents.

Review the scheme whenever the company changes structurally

As a general rule, whenever your company:

• • raises external investment;
  • introduces new share classes;
  • amends its articles or shareholders’ agreement; or
  • undertakes a group reorganisation,

the share scheme should be reviewed at the same time.

This does not necessarily mean starting again, but it may require targeted amendments to ensure the scheme continues to operate as intended and remains enforceable. A short legal review at these points is usually far quicker and cheaper than trying to resolve inconsistencies under the pressure of a transaction or dispute.

By treating your share scheme as a living part of your corporate structure (rather than a static set of documents) you reduce the risk of disputes, protect your ability to enforce leaver and exit provisions, and ensure that the scheme continues to support your commercial objectives as the business grows.

5) Weak leaver provisions (or none at all)

Leaver provisions set out what happens to shares or options when someone leaves the company. Leaver outcomes often define whether a scheme feels fair and whether it becomes a commercial headache.

No clear definition of “good leaver” and “bad leaver”

A common mistake is failing to define clearly what constitutes a “good leaver” and a “bad leaver”, or relying on vague or subjective wording. Without precise definitions, outcomes can become inconsistent and open to challenge.

For example, is someone a good leaver if they resign due to ill health? What about redundancy, dismissal without fault, or termination following a change in role? If these scenarios are not clearly addressed, the company may find itself negotiating outcomes on a case-by-case basis, which can feel unfair to other participants and expose the business to disputes.

Clear definitions also help manage expectations. Employees are far more likely to accept an outcome they dislike if the rules were transparent from the outset.

Unclear consequences on departure

Even where leaver categories are defined, schemes often fail to specify clearly what actually happens when someone leaves. Common gaps include:

• whether unvested options automatically lapse or continue to vest;
• whether vested options can still be exercised, and if so, within what time period;
• whether vested but unexercised options are forfeited on certain types of departure; and
• how any exercise price is treated if shares are acquired shortly before or after leaving.

This lack of clarity creates uncertainty for both the company and the departing individual, often leading to rushed decisions or disagreements at an already sensitive time.

Overly wide discretion for “bad leavers”

Some schemes attempt to give the board maximum flexibility by granting very broad discretion to classify someone as a “bad leaver” and determine the consequences. While flexibility can be useful, discretion that is too wide can be problematic.

From an employee relations perspective, wide discretion can feel arbitrary or unfair, particularly if decisions are made after a dispute has already arisen. From a legal standpoint, broad discretion increases the risk of challenge, especially if it is exercised inconsistently or without clear rationale.

Investors and buyers also tend to dislike uncertainty. If leaver outcomes depend on broad discretion rather than clear rules, this can raise concerns during due diligence about enforceability and potential claims.

Lack of enforceable mechanics for direct shareholdings

Leaver issues are particularly significant where employees hold actual shares, including growth shares. Unlike options, shares do not automatically lapse when someone leaves. Without robust transfer or buyback provisions, a company may have no practical way to recover shares from a departing employee.

Common problems include:

• no obligation on the leaver to transfer their shares;
• no clear valuation or pricing mechanism on departure;
• no funding mechanism for buybacks; or
• restrictions that are not enforceable in practice.

This can result in former employees remaining on the cap table long after they have left the business, potentially blocking decisions, complicating exits or creating tension with investors.

How to avoid these problems

Decide your leaver philosophy early

Before drafting any documents, it is important to decide how you want to treat leavers. For example:

• • Should long-serving employees who leave on good terms retain some value?
  • Should those who leave early or for misconduct lose all unvested rights?
  • How harsh should outcomes be for senior hires versus junior staff?

There is no single “right” answer, but having a clear philosophy makes it much easier to design consistent and defensible rules.

Align leaver outcomes across all documents

Leaver provisions should be consistent across:

• • the share scheme rules;
  • individual option or share agreements;
  • the articles of association; and
  • any shareholders’ agreement.

If these documents are not aligned, the company may find that it cannot enforce the outcome it assumed would apply. For example, the scheme may say that shares must be transferred on departure, but the articles may not support compulsory transfer.

Consistency across documents is critical, particularly where shares (rather than options) are involved.

Make the process clear and predictable

Finally, leaver provisions should be designed to operate smoothly in practice. That means:

• • setting out clear steps and timelines following departure;
  • avoiding unnecessary discretion where possible;
  • ensuring valuation and transfer mechanics are workable; and
  • communicating the leaver rules clearly to participants, especially senior hires who are likely to focus on downside risk.

Predictable, well-drafted leaver provisions reduce the risk of disputes, protect the company’s ownership structure and help maintain trust in the scheme as a whole.

Strong leaver provisions are not about punishing employees who leave; they are about creating clarity and fairness while safeguarding the company’s long-term interests. Getting this right at the outset can prevent some of the most costly and time-consuming issues that arise with share schemes.

6) Designing vesting and performance conditions that don’t work in real life

In an option scheme, vesting and performance conditions determine when options are earned (e.g. over time or when an individual meets certain performance targets). Vesting is often copied from “market norms” without considering whether it suits the business.

Overly complex or subjective performance conditions

A common mistake is designing performance conditions that look robust on paper but are difficult to apply in reality. Examples include:

• KPIs that rely on subjective assessment (such as “strategic contribution” or “leadership impact”);
• metrics that depend on future accounting judgments; or
• conditions tied to information that is not routinely produced or independently verifiable.

These issues often come to light years later, when the scheme is triggered by an exit or a departure. At that point, disputes can arise over whether conditions have actually been met, sometimes under significant commercial pressure.

Complex KPIs also create a communication problem. If participants do not clearly understand what they need to achieve to earn their equity, the motivational effect of the scheme is weakened.

Misalignment between vesting schedules and exit reality

Many schemes adopt a standard “market” vesting pattern (e.g. options vesting over four years with nothing vesting until the employee has carried out their role for at least one year i.e. a one-year cliff) without considering whether this aligns with the company’s realistic growth or exit timetable.

This can cause problems where:

• the business exits earlier than expected, leaving large portions of awards unvested; or
• the exit takes much longer than anticipated, leading to fully vested awards long before value is realised.

In either scenario, the scheme may fail to incentivise the behaviour it was designed to encourage. For founder-led or owner-managed businesses where exit alignment is a key objective, traditional time-based vesting may simply not be the right tool.

Unclear or poorly drafted acceleration provisions

Acceleration provisions determine what happens to unvested options if certain events occur, most commonly a sale of the company. This is an area where vague or inconsistent drafting frequently causes confusion.

Common issues include:

• not specifying whether acceleration occurs automatically when the company is sold, or only if the employee is dismissed or resigns after the sale has occurred;
• unclear treatment of partial vesting (e.g. whether vesting is pro-rated or fully accelerated); and
• inconsistent drafting between scheme rules and individual option agreements.

During an exit, these uncertainties can lead to disagreements between shareholders, employees and buyers, sometimes requiring last-minute renegotiation under time pressure.

Failing to address “good leavers” mid-vesting

Another common oversight is failing to deal clearly with what happens if an employee becomes a good leaver partway through the vesting period. For example, if someone leaves due to redundancy, ill health or retirement, should they:

• lose all unvested awards;
• retain a pro-rated portion; or
• continue vesting for a limited period?

If this is not addressed explicitly, the company may feel morally or commercially obliged to make exceptions, which can undermine the consistency and credibility of the scheme.

How to avoid these problems

Keep performance conditions objective and measurable

Where performance-based vesting is used, conditions should be:

• • clearly defined;
  • objectively measurable; and
  • capable of being assessed without subjective judgment.

Simple metrics are often more effective than complex ones. They reduce the risk of dispute and make it easier for participants to understand what success looks like.

Choose a vesting model that matches your commercial objectives

If your primary goal is to align employees with a future sale or exit, consider whether exit-only vesting (or a hybrid approach combining time-based vesting with exit triggers) is more appropriate than a purely time-based schedule.

Different stages of the business may justify different approaches. Early-stage companies often favour time-based vesting to support retention, while later-stage or exit-focused businesses may prioritise value creation and transaction alignment.

Draft acceleration mechanics in plain, practical language

Acceleration provisions should be written so that all parties can understand them without needing interpretation at a critical moment. This includes:

• • clearly stating which events trigger acceleration;
  • specifying how much vests and when; and
  • ensuring consistency across all scheme documents.

Clear drafting reduces the risk of disputes, speeds up transactions and gives participants confidence in how the scheme will operate if key events occur.

Well-designed vesting and acceleration provisions strike a balance between incentivising long-term commitment and recognising real-world outcomes. By keeping these mechanics simple, aligned and clearly documented, companies can ensure their share schemes deliver value without unnecessary complexity or conflict.

7) Forgetting about dilution and option pool strategy

A share scheme doesn’t exist in isolation. It impacts founder ownership, investor expectations and future funding.

Granting awards on an ad hoc basis

A common mistake is issuing equity awards opportunistically, without an overall plan for how much equity the company is prepared to allocate to employees over time. Early grants may feel modest in isolation, but without a broader framework they can accumulate quickly.

This approach can lead to:

• inconsistent awards that feel arbitrary or unfair;
• pressure to make increasingly large grants to later hires; and
• founders or existing shareholders losing sight of the total dilution impact.

When investors become involved, they will almost always ask how much equity has already been promised and how much remains available. An ad hoc approach can make this difficult to answer confidently.

Promising percentages without factoring future dilution

Another common pitfall is expressing equity awards as headline percentages – for example, “you’ll get 1% of the company” – without explaining how that percentage might change over time.

In most growing companies, dilution is inevitable. Future fundraising rounds, option pools and new share issues will usually reduce existing percentages. If this is not clearly communicated, employees may feel misled when they later discover their stake is worth less (in percentage terms) than they expected.

This is particularly problematic where offers were made verbally or without reference to a fully diluted basis, leaving room for disagreement over what was actually promised.

Failing to reserve enough equity for future hires

Early-stage companies often focus on rewarding their initial team, but fail to plan for future key hires. Without sufficient headroom in an option pool, companies may later be forced to choose between:

• diluting founders more than anticipated;
• renegotiating existing awards; or
• making smaller or less attractive offers to new hires.

Investors typically expect to see a clearly defined pool sized to support the next phase of growth. If this has not been planned in advance, it can complicate negotiations or reduce flexibility at a critical moment.

How to avoid these problems

Adopt a clear option pool strategy

A well-designed pool strategy does not need to be complex, but it should address:

• • Pool size: how much equity is reserved for employee incentives, now and in the future.
  • Governance: who has authority to approve grants and on what basis.
  • Allocation philosophy: how awards are sized by role, seniority or impact.

Having a defined pool also helps ensure that equity is used deliberately, rather than reactively.

Communicate equity in a way employees can understand

Equity can be a complex concept, particularly for employees without prior experience of share schemes. Clear communication is essential to avoid misunderstandings.

Best practice is often to explain awards in terms of:

• • the number of shares or options being granted;
  • what that represents on a fully diluted basis at the time of grant; and
  • what needs to happen for value to be realised, such as vesting, exercise and a future sale.

This approach helps employees understand both the upside and the uncertainty involved, and reduces the risk of disappointment later.

By planning dilution and option pools thoughtfully, and communicating equity awards transparently, companies can maintain trust, preserve flexibility and ensure that equity incentives continue to support growth rather than becoming a source of friction.

8) Poor employee communication (creating unrealistic expectations)

Even well-designed schemes fail if participants don’t understand what they have or what they don’t have.

Presenting options as “free money”

One of the most damaging mistakes is presenting share options or equity awards as a guaranteed upside or “free money”. This may not be intentional, but it often happens when the focus is placed solely on potential headline value without explaining the conditions attached.

Employees may not be told clearly that:

• options usually need to vest before they can be exercised;
• an exercise price may need to be paid to acquire shares;
• tax may arise at exercise or sale; and
• value is only realised if a future liquidity event occurs.

When these realities emerge later, particularly if tax becomes payable before any cash is received, employees can feel misled, even if the legal documents technically cover the position.

Failing to explain illiquidity in private companies

Another common misunderstanding is the assumption that shares can be sold whenever the employee chooses. In private companies, this is rarely the case.

In reality:

• there is usually no open market for private company shares;
• transfers are often heavily restricted by the company’s articles or shareholders’ agreement; and
• value is typically realised only on a sale, IPO or company-led buyback.

If this is not clearly explained upfront, employees may expect liquidity that simply does not exist. This can become particularly problematic if someone leaves the business and assumes their shares or options can be converted into cash in the short term.

Confusing notional valuation with real value

Employees are often shown notional company valuations (for example, from fundraising rounds or internal discussions) without sufficient context. This can lead to the impression that their equity has a tangible, current cash value.

In practice, private company valuations are:

• theoretical;
• subject to dilution, preferences and exit mechanics; and
• only meaningful if and when a qualifying event occurs.

If employees are not helped to understand this distinction, they may overestimate the certainty or timing of any payout, which can undermine trust when reality does not match expectations.

How to avoid these problems

Provide a clear participant summary

Alongside the formal legal documents, it is good practice to provide employees with a participant summary in plain-English. This does not replace the legal terms, but helps explain how the scheme works in practical terms.

A good summary typically covers:

• • what has been granted (shares, options or cash-based rights);
  • what needs to happen for value to be realised;
  • the key tax touchpoints; and
  • the main risks and limitations.

This helps ensure participants understand what they are agreeing to before they sign.

Explain mechanics in straightforward language

Employees do not need to become experts in share schemes, but they should understand the basics. This includes:

• • how vesting works and what happens if they leave;
  • when and how options can be exercised;
  • what happens on a sale of the company; and
  • how leaver outcomes affect their entitlement.

Explaining these points clearly, using examples where appropriate, significantly reduces confusion and future disputes.

Encourage independent advice

Finally, particularly for senior hires or significant awards, it is sensible to encourage participants to take independent legal or tax advice. This protects both the employee and the company.

From the employee’s perspective, it ensures they fully understand the personal implications. From the company’s perspective, it reduces the risk of future claims that the scheme was misunderstood or misrepresented.

Clear and honest communication should not reduce the motivational impact of equity incentives, but rather enhance it. When employees understand both the upside and the limitations of their equity, they are more likely to value it appropriately and remain engaged over the long term.

9) Misunderstanding phantom share schemes

Phantom share plans can be excellent where a business wants to reward people based on growth in value without issuing shares and diluting ownership but they come with frequent pitfalls.

Treating phantom shares as “equity-like” for tax purposes

One of the most common mistakes is assuming that phantom share schemes will receive tax treatment similar to actual shares or share options. In reality, phantom arrangements do not give rise to equity ownership and are generally treated as cash bonuses for tax purposes.

HMRC’s guidance makes clear that cash payments made under phantom share schemes are typically treated as earnings and taxed in the year the payment is received (subject to the specific plan terms). This means:

• Income Tax is payable at the employee’s marginal rate;
• employee and employer National Insurance contributions usually apply; and
• payments are typically processed through PAYE.

This can come as a surprise to both employers and employees if the scheme has been informally described as “equity” without explaining the tax consequences. Employees may expect capital gains-style outcomes, only to discover a significant portion of the payout is lost to income tax and NICs.

Leaving payout calculations vague or ambiguous

Another frequent issue is unclear drafting around how payouts are calculated. Phantom schemes often reference company value, share price or exit proceeds, but fail to define these concepts precisely.

Common problem areas include:

• how “value” is determined (e.g. headline sale price versus net proceeds);
• whether preference shares, debt or transaction costs are taken into account;
• how partial exits or earn-outs are treated; and
• what happens if there is no sale, but another trigger event occurs.

Vague drafting can lead to disputes at exactly the wrong moment – when a payment is due and expectations are high. Because phantom schemes are contractual rather than equity-based, disagreements are more likely to become legal disputes if the wording is unclear.

Failing to plan for the cash liability

Unlike share-based schemes, phantom arrangements require the company to pay cash when the scheme is triggered. A common oversight is failing to plan for this liability.

Problems arise where:

• multiple participants become entitled to payments at the same time;
• the trigger event does not itself generate cash (e.g. internal restructuring); or
• the business has insufficient working capital to fund the payouts.

In extreme cases, a poorly planned phantom scheme can create a significant cash-flow strain at a critical point for the business, undermining the very success the scheme was designed to reward.

How to avoid these problems

Draft clear triggers and payout formulas

Phantom schemes work best when they are drafted with precision. The plan should clearly set out:

• • the events that trigger a payout (e.g. sale, IPO, specific performance milestones);
  • the formula used to calculate the amount payable;
  • how different share classes, preferences and costs are treated; and
  • timing of payment.

Clear drafting reduces the scope for disagreement and makes outcomes predictable for all parties.

Address leaver treatment explicitly

As with share schemes, phantom plans should specify clearly what happens if a participant leaves before a trigger event. This includes whether they:

• • lose all entitlement;
  • retain a pro-rated entitlement; or
  • remain fully entitled if they are a “good leaver”.

Leaving this open can lead to difficult negotiations or claims later.

Plan for the cash payout

Before implementing a phantom scheme, companies should model potential payout scenarios and consider how payments will be funded. This includes factoring in employer NICs and the impact on cash flow.

Understanding the worst-case exposure allows businesses to decide whether caps, deferrals or staged payments are appropriate.

Ensure payroll and tax treatment is properly handled

Because phantom payouts are generally treated as earnings, payroll teams need to be involved early. Companies should ensure:

• • PAYE and NIC obligations are understood;
  • payments are reported correctly; and
  • timing aligns with payroll processes.

This avoids last-minute surprises and ensures compliance with HMRC requirements.

Phantom share schemes can be an effective incentive tool when real equity is not desirable. However, they require careful drafting, clear communication and proper financial planning. Treating them as cash-based incentive arrangements, rather than “equity-lite”, is key to avoiding costly mistakes.

10) Not aligning growth shares with the company’s actual growth story

Growth shares are often used to reward future growth above a hurdle, typically with an exit in mind. They can be powerful but they’re also easy to get wrong.

Setting an unrealistic or poorly calibrated hurdle

One of the most common mistakes is setting a hurdle that is commercially unrealistic. This often happens where the hurdle is designed defensively to protect existing shareholders, without sufficient consideration of whether it is achievable in practice.

If the hurdle is set too high:

• participants may never become “in the money”, even if the company performs well;
• the incentive loses its motivational effect; and
• senior hires may feel misled or disengaged once they understand the commercial reality.

Equally problematic is a hurdle that does not align with how exit proceeds will actually be distributed, particularly where there are preference shares, liquidation preferences or debt. In those cases, a growth share may technically be “in the money” but still deliver little or no real value.

A well-designed hurdle should be grounded in a realistic view of the company’s growth trajectory and tested against likely exit scenarios.

Forgetting that growth shareholders are shareholders from day one

Unlike options, growth shares are issued shares, not future rights. This means participants become shareholders immediately, even if the shares have little economic value at the time of issue.

This has important legal and practical consequences. Growth shareholders may have:

• statutory rights under company law;
• rights to receive notices, accounts or attend meetings; and
• potential influence over certain corporate actions.

If these governance implications are not carefully managed, companies can find themselves with an expanded shareholder base that complicates decision-making, funding rounds or exits.

This issue is often overlooked at the recruitment stage, where growth shares are presented as a “quasi-option” rather than what they actually are: a real equity interest.

Weak or unenforceable leaver and forfeiture mechanics

Growth shares are particularly sensitive to leaver issues. Because the shares are issued upfront, there must be clear and enforceable mechanisms for dealing with what happens if the participant leaves.

Common mistakes include:

• relying on informal understandings rather than binding transfer obligations;
• failing to specify whether shares must be transferred or forfeited on departure;
• unclear pricing or valuation mechanisms on a buyback; and
• restrictions that are not supported by the articles of association.

If leaver provisions are not enforceable, the company may have no practical way to recover shares from a departing employee. This can leave former employees on the cap table indefinitely, potentially blocking transactions or deterring investors.

How to avoid these problems

Ensure the hurdle is commercially credible

The hurdle should strike a balance between protecting existing value and creating a meaningful incentive. This typically involves:

• • testing the economics under different growth and exit scenarios;
  • taking account of preference structures and likely transaction costs; and
  • ensuring participants can realistically earn value if the company performs well.

A credible hurdle reinforces trust in the scheme and supports its motivational purpose.

Build robust governance and leaver protections from day one

Because growth shareholders are real shareholders, governance protections must be built into the structure from the outset. This includes:

• • appropriate voting, dividend and information rights;
  • drag-along and tag-along alignment; and
  • clear, enforceable leaver provisions supported by the articles and shareholders’ agreement.

Addressing these issues at the beginning is far easier than trying to fix them later, particularly once value has been created.

Growth shares can be an excellent tool when designed properly, but they are unforgiving of shortcuts. Careful calibration of the hurdle and robust governance and leaver mechanics are essential to ensure they deliver the intended incentive without creating long-term complications.

How we can help

At The Jonathan Lea Network, we regularly advise businesses on setting up and maintaining EMI, CSOPs, growth shares, unapproved options and phantom arrangements, and we also help with “scheme health checks” ahead of investment rounds or exits. 

We usually offer a no-cost, no-obligation 20-minute introductory call as a starting point or, in some cases, if you would just like some initial advice and guidance, we will instead offer a one-hour fixed fee appointment (charged from £250 plus VAT depending on the complexity of the issues and seniority of the fee earner).

If you are implementing a scheme (or suspect an existing scheme needs a tidy-up), please email wewillhelp@jonathanlea.net providing us with any relevant information or call us on 01444 708640. After this call, we can then email you a scope of work, fee estimate (or fixed fee quote if possible), and confirmation of any other points or information mentioned on the call.

 

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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited. 

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