Written by: J’Retha van Rensburg
25 July 2024
The Power of an ESOP to unlock Employee Potential
In an ever-growing and ever-evolving employment market, companies soon realise that retaining high-performance employees is critical to remaining competitive in the cutthroat corporate market. Enter Employee Share Option Plans.
ESOPs provide employers with a strategic tool for fostering a motivated and committed workforce. These schemes empower employees to share in the profits they help create and focus the employee’s mindset on working in a cohesive and productive corporate culture that ultimately drives sustainable growth. Employee Share Option Plans are known by many names that are used interchangeably, including Employee Share Option Schemes, Employee Share Ownership Plans, Employee Stock Ownership Plans or the informal umbrella term, ESOPs.
In this article, we’ll delve into the intricacies of share option schemes, exploring their benefits and their pivotal role in aligning employee interests with those of the company and its shareholders. Whether you’re an employer seeking to enhance loyalty or an employee aiming for wealth creation, this article offers invaluable insights for all stakeholders.
What is a Share Option Plan?
A share option plan/scheme is a structured mechanism companies employ to allocate share options to various stakeholders, including employees, advisors, and consultants. These schemes grant recipients the right to acquire a specific number of company shares at a predetermined price (the “exercise price”) within a specified timeframe. Share option schemes fall squarely within the legal definition of “securities” as outlined in Section 1 of the Companies Act, 71 of 2008. Therefore, the bonus shared with the employee qualifies as a dividend.
Share options are traditionally earned through longevity in the company or performance milestones. They will typically defer the tax payable by the employee until the point that the shares vest in the participant’s estate.
What Are The Steps to Set Up an Employee Share Option Plan?
Before a company can grant share options to its employees, it must follow a structured process to ensure legal compliance and transparency.
The initial step when setting up an ESOP is to seek approval from the company’s shareholders. When a company issues new shares through a share option scheme, the new shares will ultimately dilute the current shareholder’s shareholding percentages. All stakeholders must, therefore, be well-informed of the consequences of implementing an ESOP and consent to it.
Existing shareholders often have pre-emptive rights, which means they have the first opportunity to purchase any newly issued shares. Accordingly, not only must all shareholders be informed of the potential dilution of their existing shares in the company, but they must also execute a waiver of their pre-emptive rights to acquire these newly issued shares.
Once shareholder approval is secured, the company can proceed to prepare the best structure to suit the needs of the company. Decision makers must consider the tax implications of the structure on your employees, the dilution of the current shareholding, and the requirements the company will outline for the employees to qualify for these options.
What Should a Share Option Plan Agreement Include?
Companies can set up a formal share option scheme with its own rules that provide a structured framework for granting options, outlining how the company grants options, over which period of time options are granted, and to which employees. This formal share option scheme ensures consistency and fairness in the granting of options.
Before granting options, companies must conduct a thorough valuation of their business. This valuation determines the fair market value of the company’s shares and will ultimately determine the exercise price of the options.
The terms of employee share option plans are outlined in an agreement between the company and the option holder and are governed by detailed rules set in place by the company. The agreement specifies essential details, including:
- The number of options granted.
- The exercise price (the price at which the option holder can buy the shares).
- The exercise period (the time frame during which the option can be exercised)
How Much Equity Should Be Diluted in a Share Option Plan?
When implementing an ESOP, there is the challenging question of how much equity to dilute when decision-makers cannot yet know how much value option holders will bring to the company. It is, therefore, recommended that companies consult with ESOP specialists to assist with assessing and mitigating the risks involved.
The wonderful thing about Share Option Plans is their flexibility! Burger Huyser Attorneys can tailor a scheme to suit your specific needs, ensuring that the scheme operates in your company’s and your employees’ best interests by setting the parameters and customising the terms to suit your company.
Which Employees Should Be Granted Options in an ESOP?
Companies must establish an “option pool” consisting of a predetermined number of shares set aside for future issuance to employees to determine the number of candidates that may receive options. Possible eligibility criteria for employees to be granted options in a company may include:
- Performance criteria (e.g., meeting specific targets).
- Employment levels (e.g., senior executives, middle management).
- Compliance with company policies.
Regarding Section 97(2) of the Companies Act, companies must clearly communicate the Share Option details to eligible participants. Companies must also explain the purpose of the share options, terms, benefits, and risks. Transparency ensures that employees understand their rights and responsibilities.What is the Vesting of Share Option Schemes?
When an employer grants options to an employee as part of their remuneration package, it signifies partial ownership of the company. However, before becoming a fully-fledged owner, employees must often wait for these shares to go through a vesting process.
In this case, the vesting process involves a company giving an employee a guarantee that a certain amount of shares will be granted either after a specific period of time or after the employee has reached certain milestones. This process ensures that employees earn their share options over time, incentivising them to remain with the company.
What is a Vesting Schedule?
The vesting schedule is a timeline that outlines when the employee will gain ownership of their options or shares.
Vesting schedules ultimately fall within the company’s absolute discretion and can include approaches such as time-based vesting, milestone-based vesting, and hybrid vesting, which will be a compromise between the previous vesting approaches.What is a Vesting Period in a Share Option Schemes?
The vesting period represents the amount of time the employee must wait before their percentage of shares vest in their estate. The vesting period remains a critical aspect of equity compensation, and must be carefully decided. When the vesting period is excessively lengthy for the employees, it may ultimately cause employees to abandon their loyalty to the company.
Considering implementing an ESOP? Contact Our Experienced Attorneys Today For A Consultation
In the dynamic landscape of modern organisations, share option schemes have emerged as a potent catalyst for unlocking untapped employee potential. These schemes transcend mere financial transactions; they symbolise a profound partnership between employees and the companies they serve. Share option schemes offer a strategic approach to enhancing employee engagement, retention, and overall organisational performance.
Motivated, talented and loyal employees form the backbone of any company’s success. Permitting these key employees to participate and share in the profits of their own doing allows the employees to have a larger input in their ultimate remuneration. The power of these schemes lies not only in the collective spirit they ignite – a spirit that fuels innovation, resilience, and growth.
Contact Burger Huyser Attorneys to unlock the potential in your company by curating a tailor-made Employee Share Option Plan that best suits your company’s and employees’ needs! One share at a time will build a future where success is shared, and possibilities are boundless.
Randburg call 061 516 6878; Roodepoort call 061 516 0091; Sandton call 064 555 3358; Pretoria call 064 548 4838;
Centurion call 061 516 7117; Alberton call
DISCLAIMER: Information provided in this article does not, and is not intended to constitute legal advice. READ MORE
