Net share settlement: Overview, definition, and example
What is net share settlement?
Net share settlement is a method of settling a financial transaction, typically in the context of stock options, warrants, or convertible securities, where the payment or settlement is made in shares rather than cash. In net share settlement, the number of shares delivered is adjusted so that the party receiving the shares only gets the net amount after accounting for any liabilities, such as the exercise price or taxes owed.
For example, if an employee exercises stock options but owes taxes on the transaction, the company may settle the transaction by issuing a smaller number of shares, after deducting the amount needed to cover the taxes, rather than providing cash.
Why is net share settlement important?
Net share settlement is important because it provides a flexible way to handle financial settlements without requiring the payment of cash. This method allows for the settlement of obligations in shares, which can be particularly useful in scenarios where cash flow is limited or when the parties want to avoid cash outlays. It is commonly used in employee stock options, convertible debt, and other equity-related transactions to reduce the need for cash payments.
For businesses, net share settlement can help reduce the amount of cash outlay required for stock-based compensation or financing arrangements. For employees or stakeholders, it ensures that they can still receive value from their equity positions without having to come up with additional funds to cover the costs of exercise or tax liabilities.
Understanding net share settlement through an example
Imagine an employee has stock options to purchase 1,000 shares of company stock at an exercise price of $10 per share. The stock is currently valued at $20 per share. If the employee wants to exercise the options, they would owe $10,000 (1,000 shares × $10). However, the company offers a net share settlement, where they issue 500 shares, with the value of the remaining 500 shares covering the exercise cost. This avoids the need for the employee to come up with $10,000 in cash.
In another example, a company issues convertible bonds that can be converted into shares. Upon conversion, instead of providing the full amount of shares, the company can use net share settlement to deliver fewer shares, deducting the amount needed to cover any liabilities such as conversion costs, taxes, or other associated expenses.
An example of a net share settlement clause
Here’s how a net share settlement clause might look in an agreement:
“In the event of the exercise of stock options, the Company shall settle the transaction through net share settlement, issuing a number of shares equal to the difference between the exercise price and the market price of the shares, and withholding any applicable taxes or liabilities.”
Conclusion
Net share settlement provides a mechanism for settling financial transactions in shares instead of cash, making it an effective tool for companies and individuals involved in equity compensation, convertible securities, or similar arrangements. It allows businesses to avoid cash outlays and provides a streamlined way for stakeholders to benefit from equity positions. Understanding and using net share settlement clauses can help ensure that both parties are clear about the number of shares involved and any liabilities that need to be settled in the process.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.