Decisions, decisions. We know startup founders in Singapore have enough to consider while building their businesses, so we’ve laid out all the information to make it easier.

An Employee Stock Option Plan (ESOP) is a method of granting equity in a business to an employee over some time. As simple as it sounds, the employee receives options (or rights) to be granted real stocks in the business, as long as they comply with the rules of the ESOP (plan rules).

While there are multiple variations of employee stock plans around, ESOPs are the most common form of employee incentivisation for small and startup businesses.

In our experience, an ESOP often represents the best way to incentivise an employee’s performance whilst still allowing the company to maintain the control it desires and not tying it down with admin.

Generally, ESOPs are the most popular method of granting employee ownership for startup companies. So let’s get into why.

So what are the benefits of an ESOP?

Incentivise: We have all been in that situation. Whereas an employee feels like you are working your hands to the bones, the usual discretionary ‘bonus structure’ just doesn’t cut it anymore. ESOPs allow employees the opportunity to become part of the company. This means they have intrinsic motivation to see the company become profitable. Rather than solely focusing on their own pay cheques week to week, they are in it for the company’s greater good.
Retention: Most ESOPs contain’ time based vesting’ conditions, encouraging employees to stay at the company. This means that the options cannot be exercised (converted into ordinary stocks in the company) until they vest. And for an option to vest, the employee will have to remain employed or engaged by the company for certain periods of time. The most common terms we see involve 25 per cent of an employee’s options vesting after 12 months of employment and then the remaining 75 per cent vesting on a monthly basis over the three years commencing the after the first anniversary.
Recruiting: As a startup, you may not be able to match the corporate salaries that highly talented and experienced candidates may receive in their corporate jobs. However, by offering equity in the business, you can compromise. Many startups can attract talent by offering them a combination of salary and equity to close the gap and get the best talent on board.
Tax: Many jurisdictions worldwide have made changes allowing for ESOPs to be more tax effective for both the employer and the employee, with various concessions and methods of calculation available. An employee can be incentivised without attracting further tax liabilities with these concessions.
Customisation: ESOPs can be drafted to suit your company’s needs. The vesting conditions can be different for each employee (for example, some employees may need to meet certain KPIs, while others may only need to meet the time-based vesting requirements). This way, you can structure the ESOP to provide the most value for your company while incentivising the employees to the greatest extent possible.

Common worries

So if ESOPs are so worthwhile, why doesn’t every company have one?

Also Read: The best new year resolutions for startup founders: Offering ESOPs that actually work

We have set out below the most common concerns we hear in relation to ESOPs, and in general, most are fueled by simple misunderstandings.

“What if an employee leaves? I don’t want ex-employees leaving with equity in my company.”

Most ESOPs contain general ‘buy-back’ provisions, which allow the company to repurchase options and stocks from employees in certain circumstances. One of those circumstances is when the employee leaves.

ESOPs will specify the price paid for those stocks, often based on whether the employee was a ‘good leaver’ or a ‘bad leaver’. These terms can be completely personalised for the company to cover any hypothetical scenario it may have in mind.

“How do I know the value of the options? I don’t want to give too much away?”

Cake can help you get valuations for your company to be used in your ESOP. It can also assist with providing a valuation to put a dollar value on each option. This will be helpful when using options as a substitute for a salary.

For example, rather than paying an employee a US$100k salary, you could offer a US$75k salary, in addition to US$25k worth of options, that will vest over three years of employment at the company—more cash left in your pocket, and more incentivisation for the employee.

“How could I ever keep track of when employees are meant to be granted stocks? And how would I find time to do it?”

We hear this a lot and have solved this issue for you. Once you’ve created your ESOP on Cake, it will automatically track time-based vesting rules.

Once an employee’s options have vested (and can therefore be exercised to be issued stocks in the company), both the employee and the company will get a notification. They simply click a few buttons, and the stock issue is complete.

Also Read: 12 legal considerations when drafting your ESOP

We have created the platform on a ‘set and forget’ basis, allowing you to focus on the growth.

Difference between ESOP and ESOW

Less admin

They require much less admin. Under an ESOW (Employee Stock Ownership Plan), the employees are issued stocks upfront, subject to vesting. If the employee does not satisfy the vesting requirements, the company can repurchase those stocks at a nominal value (US$1).

However, if, for example, a company offers stocks under an ESOW to 15 employees, and only five of those employees satisfy all of the vesting requirements, the company would be required to conduct stock buy-backs for each of the 10 employees where the vesting criteria were not met.

This can be a time-consuming process, as it will require members’ resolutions, buy-back a country’s, and updates to your country’s regulator (if any).

Comparatively, ESOPs are less ofdon’tadache. If option-holders don’t meet the vesting requirements, the options will simply lapse and can then be recycled into the option pool to be used for other offers. Simple.

No upfront payment

Under an ESOP, the option-holder is not required to pay anything up-front to accept the offer.

Under an ESOW, Fair Market Value must be paid for the stocks on acceptance of the offer. This can sometimes cause confusion and delays.

The option-holder only pays when it exercises the option with an ESOP, and it is often a nominal value. A company may be able to set the Exercise Price at US$0.01 per option, even where the company is doing very well if the relevant tax rules in your jurisdiction allow for it.

No two companies are the same, so it is important to consider your own staff specifically, and your editor’s in the next few years.

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