Qualified Employee Stock Options vs Warrants

Qualified Employee Stock Options (QESOs) is a new form of incentive program available for Swedish companies that was made possible from January 1st, 2018. Previously, Swedish companies had been limited to traditional options, which can be made free of charge when received, but which are heavily taxed when exercised, or warrants, which are expensive to buy, but (mostly) taxed as capital gains. QESOs are both free of charge when the employee receives them, cost very little to exercise and taxed (in most cases) as capital gains, when the underlying stock is sold.

QESOs are a vast improvement over other kinds of incentive systems for people who are not direct shareholders. However, as good as QESOs are, they come with three major drawbacks which you must understand.

Legal uncertainty around how they are issue

Whereas traditional warrants are governed by the Swedish Companies Act (”Aktiebolagslagen”), a preliminary decision by the Swedish Tax  Authority prevents companies from issuing QESOs in the legal form of warrants. This means that a company cannot make a binding decision at a shareholders meeting to issue QESOs. The actual issuance of shares, three to ten years from the time the options where issued, requires a new decision at a shareholders meeting. Thus, theoretically, the shareholders at that future time could withhold their consent, putting the company in the awkward position of not being able to honor a commitment made to its employees. A binding shareholders agreement is therefore recommended to solve this.

No vesting the first three years

The QESO rules enforces a strict three year limit, before which no shares can be issued. Thus, a normal vesting plan will come with a minimum three year cliff, which of course is not a very attractive proposition. This can be resolved, but only in clumsy ways. It is possible to issue a traditional warrant program for the first three years, and then stipulate that if the warrants are exercised, then the QESOs cannot also be exercised. The other solution is simply to have a shorter cliff, say vesting that starts after one year. The problem then is that if options are then exercised within the one to three year limit, they become old fashioned stock-options which are heavily taxed, both for the individual but crucially also for the company, which will have to pay payroll tax. Thus, most QESO programs accept the three year cliff.

Acquisition

If a company is acquired before the QESOs have been fully vested, it is sometimes possible to enact accelerated vesting, but there are two important caveats: there is a one year limit (QESOs younger than one year at the time of the acquisition cannot be accelerated) and in order to be accelerated, the buying company must acquire the target company through a merger, rather than just buying the shares. It is hard to understand the justification to this rule, and it is fairly easy to circumvent, but the company being acquired needs to bring this situation up with the acquirer in order to make the proper arrangements.