Employee Share Option Scheme / Employee Benefit Trust
The purpose of an Employee Share Option Scheme is to provide an employer with the means of recruiting, incentivising and retaining chosen members of staff by issuing them with current or future allocations of shares in their employment company. This may be to ensure attraction and retention of key staff and as part of a succession planning programme, to motivate higher performance and profitability or to reward performance. In the interests of providing good corporate governance and ensuring the employees can have confidence in their interests being handled by a professional and impartial administrator, it is usual to appoint an independent Trustee to administer the Scheme and base the Scheme in a well regulated and reputable jurisdiction with the expertise to meet the needs of the Scheme, the employer and employees.
BASIC STRUCTURE OF THE SCHEME
An Employee Share Option Scheme is established in Guernsey.
Documentation will be drawn up by an experienced Guernsey Advocate and will consist of the following:
i)) Trust Deed
ii) Scheme Rules
The Trust Deed will set out the various powers, duties and obligations of the Trustee in administering the Scheme.
The Scheme Rules will set out specific details such as:
- will there be an internal market for issuing and selling the shares?
- the valuation method for the shares
- the vesting details for employees to qualify for their share allocation
- what happens in the event of death in service, resignation, redundancy or dismissal?
- what happens in the event of a stock market listing or sale of the company?
- the rights and obligations of shareholders and option holders
Once in place, it is usual to have a Remuneration Committee responsible for deciding the basis of issuance of share options and communicating this to the Trustee which, in turn, will issue a letter to the employee setting out their allocation and vesting details.
The Trustee keeps the records and is then responsible for safeguarding and carrying out the terms of the Trust and offers to employees. In the event of an employee leaving for whatever reason, the Trustee determines whether any shares vest or are forfeited by the employee in accordance with the terms of their offer letter and the Scheme Rules. Likewise, in the event of the sale of the company or a stock market listing, the Trustee will act in accordance with the Scheme Rules in ensuring the interests of the employees are protected. For further details, please contact FNBIT to discuss your specific requirements.
As companies establishing ESOPS are typically privately owned and do not therefore have a market price, it is important to determine the basis of the issue price to be used for employees and also the ongoing means of valuation.
The easiest method is to utilise an independent agent to recommend a basis for valuation and then to ensure that is to be used for the life of the Scheme. It is equally important to engage the services of an independent agent to carry out the valuation to ensure consistency and impartiality for both employer and employee. Suitable agents would include a reputable firm of accountants.
Sample methods of valuation are usually based upon a multiple of earnings per share, say 5 times, for instance. The multiple will depend upon the type and nature of the company, the market it is operating in and the nature of the industry and valuations for similar companies in the same field. This is where the expertise of an independent agent well versed in this type of work is essential.
Employees then know that the value of their shares is directly linked to the profitability of the company, which is also in the interests of the company itself.
It is usual for the valuation to be carried out annually and based on the audited year end accounts.
Basis of Issuing Share Options
There are many permutations that can be put in place. The method chosen depends upon the specific needs of each company. objectives an example, one option would be:
Options can be granted to key employees when they join as part of their contract. For other employees, they are granted by the Remuneration Committee, usually on an annual basis once the new share price has been calculated after the annual audited accounts have been prepared.
Each employee deemed appropriate would receive an allocation, which would vest as to one third after 3 years, one third after 4 years and the final third after 5 years. The first third could be sold after three years, the second third after 4 years and the final third after 5 years.
To avoid forcing the employee to exercise options whilst the share price may not be favourable, it is usual to give the employee the right to defer the sale of all of their allocation till year 5 if required.
In this way, the employee can see a line of sight to an incentive after three years but does not have access to the final amount until five years. This ensures they stay motivated to contribute to profitability throughout their employment.
It is also possible for the Remuneration Committee to issue further allocations to an individual each year so that at any time, the employee has a five year lock in to the company and knows if he leaves, he will be giving up that remaining part of his incentive package.
Exit Options for the Employee
Once an employee has earned a right to exercise an allocation of shares, they will usually have the right to either retain the physical shares or will, more often, wish to be able to sell them and realise cash.
As there is unlikely to be a market for employees to sell the shares, unless the company has been floated through an IPO, the company will most likely wish to put in place a mechanism for the company to buy the shares from the employee at the prevailing price for that year. An employee will then know what price he will receive in advance.
If there is no such mechanism, this could be seen as a disadvantage to the employee as they will be left holding shares with no discernible means of sale.