Employee share option plans (ESOP) are schemes which companies put in place to grant participants such as employees the option to acquire shares in such companies under certain pre-agreed terms, for example, after having worked in the company for a certain period of time. An ESOP is a type of equity incentive plan which, if optimally utilised, provides significant benefits to both business owners and employees.
For start-ups which are cash-strapped and are unable to remunerate their employees, consultants and advisers at a level matching those of leading industry players, they may consider utilising ESOPs as an alternative means of payment for services rendered to them.
By providing participants such as employees with the opportunity to acquire shares in the company by way of vested share options (Options), ESOPs motivate participants to work in a way that is aligned with the medium to long-term interests and growth of the company.
Moreover, the terms of an ESOP can be designed such that employees must remain with the company for a minimum amount of time before reaping the benefits of the scheme, making it an efficient way for start-up owners to retain talent.
ESOPs may also be utilised as a solution for individual business owners who are looking to retire, but would rather hand the company over to their family members, long-time employees or professional managers than sell it to an outsider. A well-implemented ESOP strategy allows business owners to improve their personal financial liquidity over time while simultaneously enabling them to transfer a percentage of their share ownership in the business to successors whom they trust to continue running their business.
Where a succession team is not yet clearly established, an ESOP strategy may be used to prepare the next generation successors to inherit the business over a pre-determined timeframe.
Business owners also have the option to create immediate liquidity by selling their stock to an ESOP pool while still retaining management control. This approach has the advantage of preventing the need for business owners to sell equity in the company or borrow from third-parties to raise funds for personal use.
For all their benefits, however, the implementation of ESOPs is a complex process, with multiple factors to be considered. Business owners should thus protect their interests and avoid misunderstandings by including terms and conditions in their ESOP rules that are unambiguous and specific. While some factors to consider when drafting these rules are introduced below, it is important to consult with legal counsel during this process, especially because the implications of certain scheme conditions may be unclear to someone who is not legally trained.
(a) Size of Option Pool
Arguably the first decision to make when setting up an ESOP is the size of its option pool (Option Pool). The Option Pool is the treasury of shares that the company reserves for ESOPs. While there is generally no statutory limit on the size of the Option Pool, it typically ranges from 7.5% to 15% of issued and paid-up share equity of a company.
Although the size of the Option Pool can fluctuate over the lifecycle of the company, it is important to remember that the size of the Option Pool has an impact on equity dilution and thus on future valuations of the company.
(b) Participants
Whilst there is in general no limit to the number of participants who may be included in an ESOP, it should be noted that there is a limit on the number of shareholders a Singapore-incorporated company can have to remain as a private company. The eligibility criteria for an ESOP is determined by the company’s board members, who have the scope to extend the award of Options to non-employees such as directors and consultants, amongst others. Whilst the award of Options is a commercial matter, business owners must keep the requirements of the Companies Act 1967 of Singapore in mind when deciding on the scope of eligibility. There are also prospectus exemptions under the Securities and Futures Act 2001 of Singapore which can be relied on when offering ESOPs to employees and non-employees.
(c) Option Price, Exercise Price, and Vesting Period
The option price (Option Price) is the amount which a participant pays to be granted the Options, and is set based on the discretion of the company. Given that the primary goal of an ESOP is to remunerate and motivate employees, the Option Price is usually set at a nominal value (e.g. $0.01 per share) to incentivise employee participation.
The exercise price (Exercise Price) is the amount participants must pay to exercise their vested Options. While there are no legal restrictions, the Exercise Price is usually set at either the nominal or fair market value. An Exercise Price set at a nominal value is more attractive to participants as they will enjoy greater gains. There are tax considerations when rewarding participants with Options, which tax professionals will be best-placed to advise on.
The vesting period (Vesting Period) is the time it takes for participants to be allocated their granted Options and the Vesting Period for employee participants usually spans between 3 to 4 years. This timeframe may only commence after a cliff period (Cliff Period) (i.e. a period within which the Options would not be vested), after which Options will begin to vest.
(d) Forfeitures and Cancellations
Business owners should also stipulate in their ESOP rules the scenarios which would lead to the forfeiture or cancellation of Options which have been awarded. Generally, employees that depart the company during the Cliff Period are not entitled to receive any Options. Where their departure occurs during the Vesting Period, they are entitled to the number of Options vested, while non-vested Options will be forfeited. These rules should also include the company’s reverse vesting rights, so that shareholders, particularly those who hold shares with voting rights, waive these rights upon departure. Forfeiture rules may also differentiate between ‘good leavers’ and ‘bad leavers’, distinguishing how each type of employee should be treated upon departure.
(e) Administrative Requirements
ESOP rules must clearly state the administrators who are appointed to administer the scheme, so as to avoid any conflict of interest from arising. These administrators are usually the directors or senior executives of the company, excluding those who have personal interests in the grant of the particular share options. Singapore’s employer-friendly regulations means that employers are afforded a large amount of discretion when drafting ESOP provisions. Seeking the advice of legal counsel would be a practical way to increase the likelihood of the ESOP provisions being well-balanced and unambiguous.
When successfully implemented, ESOPs provide significant benefits for employees and business owners of both start-ups and mature companies. By providing participants with share ownership in the company, ESOPs confer a sense of responsibility, thereby aligning the participants’ personal goals with those of the company. Business owners who are considering implementing or expanding their ESOPs should keep in mind that the framework and management of incentive schemes is complex, and the considerations introduced above only provide a preliminary overview into such schemes. Legal counsel should therefore be engaged to ensure that the scheme optimally balances incentivising workers with the business interests of the company.
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Our firm frequently draft and advise on employment share option plans for employers and advise employees on their rights under such plans.
The author, Waltson Tan, is a corporate lawyer trained in London and Singapore. He is qualified as an advocate and solicitor in Singapore, and has more than eight years of post-qualification experience.
Waltson focuses his practice on mergers and acquisitions, private equity, joint ventures, investment funds and other general corporate and commercial transactions. He has also represented numerous leading multinational organisations on a broad spectrum of corporate, regulatory, cross-border restructuring and employment matters.
Waltson also advises clients on a monthly and yearly retainer basis, where he provides dedicated services to each client in relation to the issues which clients face, including general corporate and employment related matters.
If you require further information and/or expert guidance on the above or any other area of law, you may wish to contact the author of the article, whose details are as follows:
Waltson Tan Director +65 8079 0028 waltson.tan@28falconlaw.com |
Office address: 101A Upper Cross Street #13-11, People’s Park Centre Singapore 058358 |