The term sheet runs to four pages and one line of it says founder vesting: four years, one-year cliff, standard reverse vesting. Everyone in the room understands the commercial point. If a founder walks in year two, the company can buy back the shares they have not yet earned.

What is almost never said out loud in that meeting is that the line has just moved those shares into a different part of the tax code, and that a one-page form with a 14-day deadline is now running. In the wrong circumstances, missing it turns an exit that should have been taxed at 18% into one taxed at 45% with National Insurance on top.

Reverse vesting is not the same thing as options

Under reverse vesting you already own the shares. They are issued to you on day one, they carry votes and dividend rights, and the capital gains clock starts running. What the company gets in exchange is a contractual right to buy some of them back, usually at the price you paid, if you leave before the vesting schedule completes.

Options are the mirror image: you own nothing until you exercise. Investors ask founders for reverse vesting rather than options precisely because the founders stay on the cap table, which keeps the two-year clocks for Business Asset Disposal Relief running and avoids disturbing an existing SEIS or EIS position. It is the right commercial answer. It is also what creates the tax problem.

A buy-back right is a "restriction", and that changes which rules apply

Shares acquired by reason of an employment or an office are employment-related securities under Part 7 of the Income Tax (Earnings and Pensions) Act 2003. Founder shares almost always are: the founders are directors, and HMRC does not accept that a founder's shares are somehow unconnected with the job.

A right for the company to reacquire the shares for less than they are worth if the holder stops working there is a forfeiture condition, and shares carrying one are restricted securities under section 423. From that moment your shares have two values rather than one:

  • Unrestricted market value — what the shares would fetch if the buy-back right did not exist.
  • Actual market value — the lower figure a buyer would pay knowing it does.

Every question that follows turns on the gap between those two numbers on the day the shares were issued.

Nothing happens on day one, and that is exactly the trap

Section 425(2) says that where a forfeiture condition will end within five years of acquisition, there is no income tax charge when the shares are acquired. Four-year vesting sits comfortably inside that, so nothing appears on anybody's tax return, no cash leaves anybody's account, and the whole subject goes quiet for four years.

The charge is deferred, not cancelled. Section 427 sets out three chargeable events: the restrictions being lifted, the restrictions being varied, or the shares being sold to an unconnected person while still restricted. A trade sale is the third one, which is why this surfaces at the worst possible moment, in the middle of a completion timetable.

What gets charged is a proportion of the value at that moment. The proportion is fixed on day one: take the unrestricted market value when the shares were issued, subtract what you actually paid for them and anything already taxed as income, and divide by that unrestricted value. Pay the full unrestricted value and the proportion is nil, permanently. Pay £20 for shares worth £240,000 and the proportion is 99.99% — and that is the share of your exit proceeds that arrives as employment income rather than as a capital gain.

The election, and the fourteen days

Section 431(1) lets the employer and the employee jointly elect to treat the shares as though they had never been restricted. The trade is explicit. You accept an income tax charge now, on the full unrestricted value less whatever you paid, and in return every penny of growth after that date is a capital gain.

Three practical points about the form itself. It must be made not later than 14 days after the date the shares are acquired, and that deadline cannot be extended — there is no late-election procedure and no reasonable excuse provision. It has to be signed by both the company and the individual. And it is not sent to HMRC; it is signed, dated and kept with the company's statutory records, which is precisely why it goes missing.

Worked example: the co-founder brought onto the cap table at seed

The figures below are illustrative, but the shape is the ordinary one. A company incorporated fourteen months ago has two founders holding 800,000 ordinary shares each, subscribed at £0.0001 when the business was worth nothing. Their position is clean: they paid the full unrestricted value, so their uncharged proportion is nil whatever happens later.

The seed investor wants the CTO, who joined at month nine, on the cap table. She is issued 200,000 ordinary shares at £0.0001 — £20 — subject to four-year reverse vesting with a one-year cliff. The round closes at a post-money valuation of £2,400,000 across 2,000,000 shares, so the shares are worth £1.20 each and her stake has an unrestricted market value of £240,000 on the day it is issued. She is on a £30,000 salary. Four years later the company sells at £6.00 a share and her 200,000 shares fetch £1,200,000.

Path A — no election signed
No charge on acquisition, because the forfeiture ends within five years. Uncharged proportion: (£240,000 − £20) ÷ £240,000 = 99.99%.
The sale is a chargeable event, so £1,199,900 is taxed as employment income.
Income tax, on top of her salary: £536,172
Employee National Insurance at 2%: £23,998
Employer National Insurance at 15%: £179,985
Capital gains tax: nil — the income charge lifts her base cost to £1,199,920
Path B — section 431 election signed within 14 days
Income tax now on £240,000 − £20 = £239,980, landing on top of a £30,000 salary: £104,208, due the following 31 January.
On the sale: gain of £960,000, less the £3,000 annual exempt amount, at the 18% Business Asset Disposal Relief rate: £172,260
Total: £276,468
The same £1,200,000 exit taxed two ways: £740,155 of tax with no section 431 election against £276,468 with one The same shares. The same exit. One signature apart. £1,200,000 of proceeds. Illustrative figures, 2026/27 rates. No election Tax £740,155 Kept £459,845 Section 431 election £276,468 Kept £923,532 Difference: £463,687, once the employer’s National Insurance is transferred, which sale agreements usually do. Path B pays £104,208 four years earlier, on shares that cannot yet be sold. That is the real cost of the election.

Strip the employer's National Insurance out and the gap is still £283,702 of personal tax. Leave it in, as the sale agreement almost certainly will by way of a joint election transferring it, and the gap is £463,687.

Free at incorporation, expensive nine months later

Look again at what Path B actually costs: £104,208 of income tax, payable the following January, on shares that cannot be sold and might be worth nothing. That is not a trivial signature. It is a genuine decision, and for a co-founder without that cash to hand it can be an impossible one.

At incorporation the same election costs nothing at all. Subscribe for shares at nominal value on the day the company is formed, when there is no product, no revenue and no term sheet, and the unrestricted market value is what you paid. The charge on election is pennies, and the uncharged proportion is nil in any event. Sign it anyway, because the election is insurance against HMRC forming a different view of what the shares were worth — which is what happens when founders subscribe after the intellectual property has been assigned in, after the first customer has signed, or after a term sheet is on the table.

The window between those two positions is narrow and it closes fast. Every month of traction makes an ordinary share issue at nominal value more expensive to fix.

What to give someone who joins after the company has value

Not ordinary shares at nominal value. By then the choice is only between a large tax bill now and a larger one at exit, which is a bad menu. Two structures exist precisely for this:

  • EMI options. No income tax on grant, and none on exercise where the option was granted at not less than the actual market value agreed with HMRC. Business Asset Disposal Relief is available on the resulting shares without the usual 5% personal company test, and the two-year clock runs from the date the option was granted rather than exercised. Our post on the 2026 EMI limits and qualifying conditions covers who can use it.
  • Growth shares. A separate class that only participates in value above a hurdle set at the current valuation. Because the class is worth very little on the day it is issued, it can be subscribed for at close to its unrestricted value — which brings the uncharged proportion back to nil and makes a section 431 election cheap again.

Both need a defensible valuation and both need doing before the shares or options are issued, not afterwards.

The return that nobody remembers

Issuing employment-related securities creates an annual reporting duty. The arrangement has to be registered on HMRC's Employment Related Securities online service, and an annual return filed by 6 July following the end of the tax year, including nil returns once a scheme is registered.

The penalties are automatic and they escalate: £100 on 7 July, a further £300 if the return is still outstanding three months later, another £300 at six months, and £10 a day from nine months. Paying a penalty does not discharge the filing obligation, so the clock keeps running until the return goes in.

What to do this week

  1. List every share issue the company has ever made and put the date, the price paid and the number of shares against each one.
  2. For each issue, find out whether a section 431 election was signed and where the signed copy is. "The lawyers will have it" is not an answer; go and look at the document.
  3. Flag any issue made in the last 14 days. That is the only window in which the position can still be chosen rather than inherited.
  4. For every issue where no election exists, work out what the shares were worth on the day and what was paid. The gap between those two figures, expressed as a percentage, is the share of a future exit that is exposed to income tax.
  5. Check whether the company is registered on the Employment Related Securities service and whether the 6 July returns have been filed for every year since the first share issue.
  6. Before the next round closes, agree with your lawyers that the section 431 election is drafted, signed and dated on the same day as the share issue, not left to the post-completion bundle.
  7. If anybody is about to be given ordinary shares at nominal value in a company that now has a valuation, stop and price the alternatives first.

Our guide to paying yourself as a founder covers the salary and dividend side of the same question, and if you are raising rather than granting equity, the comparison of an advance subscription agreement against a convertible note sets out the instrument choice. Founders relying on SEIS and EIS should read that alongside this, because share reorganisations can disturb an existing relief.

Where we help

We work out the unrestricted market value on each share issue, get the section 431 elections signed inside the 14 days, register the scheme and file the annual returns, and model the EMI or growth share alternative before anybody signs a stock transfer form. Where elections were missed years ago, we quantify the exposure so it is a known number in the data room rather than a surprise in due diligence. Banded fixed fees from £49 + VAT a month. Get started.