As many young talents are leaving high paying jobs in established companies to join startups in hopes of being part of the next unicorn (a startup which is valued at over $1 billion), founders are facing a tougher time between balancing the need to scale their business fast while managing investors expectations. While doing these, the founders have to also make sure that their teams continues to stay with them to achieve the desired business goals. So how can startups retain their talents?
Employee Shares Option Schemes or better known as ESOS is a great way for startups to retain key management team or talents.
In this article, we provide an overview of ESOS and certain issues that a startup should consider before implementing such scheme.
What is Employee Shares Option Schemes (ESOS)?
It is a form of an option offered by the company (usually by the board of directors or the options committee) to its eligible employees to acquire shares in the company at usually discounted rate.
The by-laws is a set of terms and conditions setting out the responsibilities between the company and the eligible employee. The by-laws will usually contain the following key terms:
- conditions to be eligible for options
- details of the option shares
- exercise price for the option shares
- ownership structure for the option shares
- duration of the scheme
The by-laws and the resolutions have to be passed by the board of directors and shareholders of the company. Therefore, it is important that the company secretary of the startup is aware of the statutory requirements and to assist the company in preparing the requisite resolutions.
Eligible employees would refer to any full time staff as the company may determine in its by-laws. Freelancers may also be eligible for ESOS provided that the by-laws permits it.
The ESOS shares refers to the option pool which the company may allocate from time to time. Typically, in a public listed company scenario, it may not be beyond 10% of the issued paid up capital of the company.
However, the ESOS shares may also be transferred from the founders or promoters’ block of (existing) shares of the company. In this instance, the transferor will transfer the shares to the eligible employees. The eligible employee should take note of the stamping fee that will be applicable based on the value of the option shares (more on this below).
After the board of directors of the company has confirmed the eligible employees, the company shall issue an offer letter to the eligible employee setting out the terms of his or her offer.
An offer letter is an offer by the company to the eligible employee to acquire the ESOS shares. A timeframe for the employee to accept the terms is set out in the offer letter and hence it is important that the eligible employee accepts within the timeframe.
When the eligible employee accepts the offer, the said employee is required to pay the option price based on the aggregate option shares offered. Under contract law, an offer and acceptance will only be valid when there is an exchange of value or known as consideration i.e. payment of option price by the eligible employee to the company. Option price refers to the price that the eligible employee has to pay to the company to be entitled for the option shares. Therefore, even though the startup may intend to give out “free shares” to its eligible employees, the law mandates that there should be a nominal consideration to be paid by the eligible employees. Nominal consideration can be as low as RM1.00 or a higher amount, such as RM100.
Since the fundamental goal of an ESOS scheme is to retain talents, the by-laws will set out the duration upon which the eligible employee has to remain in employment with the company. However, as an eligible employee, it is important to understand that the exercise of such option does not mean that the employment contract cannot be terminated under the circumstances set out in the employment contract. Should there be any form of misconduct or breach of contract by the employee, the employer can terminate the employment contract, and arising from such termination, the option shares may revert back to the founders.
Typically, a startup may issue direct equity in the company to its eligible employees.
Alternatively, a startup may also form a vehicle such as a private limited company or a limited liability partnership to own the ESOS shares. This may be considered in the event that the company plans to give out the ESOS offer to many eligible employees or to aggregate the ESOS shares under a vehicle. The purpose of a vehicle is to facilitate the eligible employees to own shares in the company. In the case of a limited liability partnership, the partnership shall administer the issuance of partnership units to ensure the eligible employee’s effective equity interest in the company.
ESOS is a great way to incentivise and motivate talents to stay in the company. As a founder, if you have an existing investor in the company, chances are, the approval from the investor will be required as such scheme will amount to variation of the shareholding structure and would be a reserved matter in the shareholders agreement.
- If you haven’t started any fundraising, it may be a good idea to implement the ESOS scheme. Write to us as to how we can help you.
- If you are currently considering investments from prospective investors, we suggest that you negotiate for ESOS to be implemented in your company and include this term in the term sheet and definitive agreements.
- If you already have received investments, you may want to speak to your investors if they are open to the idea of implementing ESOS as issuance of any new shares would dilute the investors’ shareholding and they may instead prefer that the founders themselves allocate shares from their own block (ie transfer of founders’ shares).
If you’d like to know more about issuing ESOS to your employees, drop us an email at firstname.lastname@example.org.